J.P. Morgan Asset Management has published an update of its long-term capital markets assumptions in the form of an extensive new report that, in addition to making baseline economic assumptions about the next five to 10 years, presents various thematic articles on specific, current trends.
Among these is a close look at environmental, social and governance (ESG) investing, particularly how institutional investors in the United Sates are warming to ESG approaches and their potential role in investment processes and decisions.
As the report explains, interest in sustainable investing is growing globally among a wide range of market participants. While some investors have long been motivated by environmental or societal objectives, others are seeking new financial opportunities in the companies that stand to benefit from rapid changes in consumer preferences, policy and regulation, spurring further interest in sustainable investing. All this to say: Grappling with ESG investing in today’s marketplace is a potentially challenging affair that brings with it substantial opportunities.
According to J.P Morgan’s analysis, in general, investors tend to consider ESG factors either to increase risk-adjusted returns (which the report calls “doing well”) or to achieve sustainable outcomes (i.e., “doing good”). In their analysis of this bifurcated framework, J.P. Morgan’s analysts find no meaningful trade-off between doing good and doing well when investing in public markets.
“A sector-neutral equity portfolio is not hindered, relative to its benchmark, by a skew toward ESG leaders, defined as companies that perform well on J.P. Morgan Asset Management’s ESG scoring framework,” the report explains. “In fixed income, while there is evidence that higher-ranked ESG issuers pay lower coupons, investors are likely to be compensated with lower default risk.”
J.P. Morgan’s analysts say there are two channels through which sustainable business practices can help companies outperform their peers and generate higher returns for investors. The first channel is market forces, the report explains, where the costs of nonsustainable practices play out and can hurt a company, either because it suffers the effects of regulation or because it fails to meet consumer preferences. The report suggests this “market forces effect” will be persistent through time.
The second channel is via increased demand—and thus higher prices—for these companies’ shares relative to their lower-scoring peers. The report calls this a “repricing” effect, suggesting it may likely be transient as market participants price in ESG considerations more accurately.
At a high level, the report states, total return results will vary depending on which of the many ESG rating systems are being used. As such, across both equities and fixed income, choosing an ESG rating system that produces reliable ESG “scores” is a critical choice in sustainable investing.