Investment Strategy

How ethical investing could lead to more than just bumper returns

The environmental, social and governance (ESG) values of a company are becoming more and more important to making investment decisions and can lead to positive results, according to experts in the industry.

The trend of ESG investing only became relevant in the past few years, but is now becoming part of the mainstream investing paradigm, according to Hendrik Bartel, co-founder and CEO of data firm TruValue Labs. Events that have pushed forward ESG concerns include the Volkswagen emissions scandal and the fraud revelations at Wells Fargo.

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Bartel started his company about four years ago. It provides ESG data and software to investors and asset managers. According to Bartel, a lot of ESG data can be flawed.

"It's very retrospective. It's very subjective and extremely expensive, as it is human-curated and there are lots of biases that come in. Lots of the data is self-reported," he told CNBC via email.

Instead, TruValue Labs uses artificial intelligence to sift through data and highlights anything relating to ESG criteria. The company claims that access to real-time ESG data reduces risk, reveals opportunities, and keeps companies accountable.

The importance of data

Companies are increasingly understanding the importance of reporting on their ESG values. A report from audit firm PwC in October showed how quickly this change has happened.

"The percentage of S&P 500 companies issuing sustainability reports has jumped to 80 percent in 2015 compared to 20 percent in 2011," said Sara DeSmith, U.S. sustainable business solutions assurance leader at PwC, in a press release.

"With this increased reporting comes added expectations from investors on what these findings mean for them when taking a stake in a company."

Bartel claimed that investors who incorporate ESG into their decision making would see a positive uptick on their returns.

"That's what we are starting to see with some of the pioneers that have successfully implemented an ESG strategy," he said.

In fact, a Hermes report from September looked at the value of ESG investing and found share prices of well governed companies performed better than those of poorly governed companies by an average of 30 basis points.

"It's a risk mitigation factor," added Bartel. "A risk measurement that can be applied. I think ESG is a measure of transparency: it's sort of knowing what you invest in and agree with the company on how they do things."

As an example of the potential of ESG investing, here are two charts which show the 12-month performance of two contrasting funds.

The first, is the USA Mutuals Vice Fund, which invests in stocks in the so-called "sin" sector: Arms, gambling, tobacco and alcohol. Over 1 year, the fund is up around 6.5 percent.

A chart of the performance of the USA Mutuals Vice Fund over the past 12 months

The second fund is JOHCM U.K. Opportunities. Ratings agency Morningstar gives the fund an above average sustainability score based on the portfolio's ESG score. Over 1 year, the fund is up around 12.3 percent.

A chart of the performance of JOHCM U.K. Opportunities over the past 12 months

What the asset managers think

Bob Smith is president and CIO of Sage Advisory, an asset manager that leverages ETF (exchange-traded fund) strategies and with over $12 billion of assets under management, which uses due diligence and ESG as part of its selection process. He says investors are increasingly aware of environmental concerns and governance issues.

"I think that there's a growing social awareness of a number of different issues that need to be addressed and those companies that address them appropriately and manage them appropriately report on their successes as a result of that, more and more people are inclined to want to be associated with those movements," he told CNBC in a phone interview.

Sage's ETF strategy is to examine the ESG and sustainability factors of a fund's constituents and gives it a group score, then compares it with other funds.

"In doing so, what we want is the upper crust of all those entities that really manage their environmental, social and governance issues at a very high level compared to their peers," he said.

According to Smith, companies outside of the U.S. have shown more commitment and focus on ESG.

"That's not to say U.S. companies have not been focused, but you'll find that there's a lot more companies globally and outside the U.S. that have really taken the bull by the horns. Having said that, I think that there's a very rapid acceleration going on in the United States," he said.

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