Is it a risk? Socially responsible investing

You’re a good person. You’re socially responsible. Your money isn’t going to be used to kill whales, grow tobacco or buy arms. But are you saving the world, or just financially astute? UQ Business School’s Dr Darren Lee has looked at the numbers and says corporate social performance indicators have no financial impact at all – socially responsible investing is risk and return neutral.


“The social responsibility of business is to increase its profits” wrote Milton Friedman, American economist, Nobel Prize winner and economic advisor to US President Ronald Reagan. He argued – as have his many followers since – that devoting company funds to anything other than increasing profits is irresponsible. Environmental, social and governance (ESG) issues, like paying workers above award wage or supporting community projects, reallocates wealth from the shareholders, the rightful owners of the firm. It’s an argument that has largely gone out of fashion.

In fact, says Dr Darren Lee, the pendulum has swung the other way. By not incorporating ESG issues into their analysis, fund managers are considered short sighted – even negligent. And not from a moral stand. It’s increasingly the case that firms that integrate ESG are considered better able to protect their brand and reputation and are less likely to engage in irresponsible, value-destroying business practices.

Not that companies have much choice. In the UK, companies are formally mandated under the Companies Act to disclose ESG information, and Australia is not far behind. The Financial Services Council and the Australian Council of Superannuation Investors have produced a guide to ESG reporting that outlines the information that companies should consider and disclose, to create consistency and comparability of data across different companies and sectors. It is a first step towards meaningful disclosure of ESG risks and, arguably, on the path to compulsory disclosure.

Stock exchanges in Australia, France, India, Malaysia, South Africa, Sweden, Taiwan and Thailand all have formal ESG requirements, and many more have voluntary reporting guidelines.

But, asks Dr Lee, is there money in it? Keen to measure the actual impact of reporting ESG activities on company value, Lee and colleagues Jacquelyn Humphrey and Yaokan Shen examined whether corporate social performance (CSP) ratings impact performance (cost of capital) and risk.

Despite the massive growth in ESG reporting in the past decade, the research found that, on balance, there is no impact on risks and returns if your fund manager uses it as an analysis tool. On the up side, there is no cost if a fund manager is required to use the tools, and on the down side no benefits to the investor. It’s market forces, argues Lee. “If you could make money from being socially responsible in an efficient market, returns would be eroded over time as even unethical investors would see a means to make money and join in.”


There are two factors to consider. The information needs to add value and the analyst needs to have the skill to identify that information.

During the recent financial turbulence, for example, investors could have made money betting against the poor governance of companies like Merrill Lynch or Enron. Some investors may have done so, but most didn’t. This represents a lack of sophistication in ESG reporting, according to Lee. He believes that, over time, as ESG reporting becomes more widely adopted, the information it provides to investors will be increasingly sophisticated and so relevant and useful.


Globally ESG is big business. Witness the development of United Nations Principles for Responsible Investment (UNPRI). The UNPRI is aimed at integrating ESG issues into investment decision-making and helping to create a sustainable global financial system. There are more than 1000 UNPRI signatories, representing over US$30 trillion in assets around the world.

Almost 60% of funds under UNPRI are in Europe. “India, China and the Middle East are the new frontiers,” says Dr James Gifford, UNPRI founding Chief Executive. “In China, in particular, there is an absolute recognition that, at least from the corporate governance and environmental side, this is where things should head.”

Gifford is also pushing for more involvement with owners of other asset classes.

“Asset owners hold the key to driving responsible investment throughout the investment chain,” says Gifford. “Most of the problems we face are a combination of short-termism and principal-agent problems. Asset owners are the only group within the investment chain that can really take these on.”

So, if investing in firms with good ESG practices offers the same risk and returns as not taking into account ESG, yet makes the world a better place, how can we get more investors to do the right thing? We need to look at the information we provide.

Fund managers are essentially Friedmanites. Their duty to their clients is to maximise returns for a given risk. ESG is just another tool in their financial analysis toolbox. If investors want them to use this tool and incorporate ESG into decision-making, we need to ensure that information is financially useful.

According to David Deverall, CEO of ethical investment fund managers, Hunter Hall, responsible investment funds on average out perform the market in the short, medium and long term. But, he says, market performance is complicated and not tied exclusively to results.

Deverall believes there are a number of factors at play when evaluating the impact of ethical activities on returns: “You need a nonsense check in any analysis,” he says. For example, companies with a poor environmental record or who have governance issues come under intense scrutiny. With pressure, performance suffers. Company value drops.”

There’s also an issue about the definition. “Labels come and go: CSR (corporate social responsibility), ESG (environmental, social, governance), now UNPRI (United Nations Principles for Responsible Investing) are used enthusiastically at different times. But the definitions are so broad that meaningful comparisons are difficult.”

“Even within Hunter Hall we have an ongoing discussion about precisely where the ethical line sits. We exclude armaments, tobacco, animal exploitation and gambling, for example,” he explains, “but should the fund exclude a company like Woolworths, who own pubs, and whose pubs have gaming machines? It’s an ongoing debate.”

To ensure traders are clear about where funds are going, a range of screening tools are available that rate ASX stocks according to whether or not they are involved in certain activities. “It’s added a level of complexity – but it’s meeting investor demand for clarity at a time where socially responsible business practices are getting attention.”

“There’s also a cyclical element to ethical investing. In a downturn, investors lean more to protecting value. It’s the hip pocket that drives decisions when times are tough.”

“At Hunter Hall,” says Deverall, we firmly believe that the option isn’t ethical or profitable, but ethical and profitable. That’s what drives our investment decisions.”


According to the Financial Services Council and The Australian Council of Superannuation Investors, companies must consider reporting on

- Climate change
- Environmental management systems and compliance
- Efficiency (waste, water, energy)
- Other environmental issues (e.g. toxics, biodiversity) etc

- Workplaces health and safety
- Human capital management
- Corporate conduct (e.g. bribery and corruption)
- Stakeholder management/license to operate

- Corporate Governance


If you would like to learn more about the research in this article, then take a look at:
“Does it cost to be sustainable?” Journal of Corporate Finance, 2012

Last updated:
25 February 2019