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ESG’s Influence on a Portfolio

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Investing with environmental, social and governance (ESG) strategies historically has not meaningfully helped or hurt long-term performance, according to Northern Trust Wealth Management research.

That said, ESG-focused funds can have a different balance of factors driving risk-adjusted returns—and those differences may cause ESG-investing strategies to diverge from conventional benchmarks.

Investment Factors and ESG Funds

Investment factors are specific, quantifiable characteristics, such as size, value and profitability, that drive an investment’s risk and returns. Every portfolio has a mix of exposures to investment factors, and the mix tends to differ between ESG funds that have an ESG mandate and conventional funds that do not.

Northern Trust Wealth Management analyzed a universe of over 900 U.S. equity mutual funds to better understand how investment factors differ between ESG funds and conventional funds. The research showed that:

ESG funds tend to have greater exposure to:

  • Larger investments, as measured by market capitalization
  • Growth investments, by which expected earnings of the company increase at an above-average rate compared to their sector or the overall market
  • Higher quality investments, typically described as companies with a strong balance sheet that are consistently profitable and growing*

This clear difference in investment factor exposure is important to understand, especially when evaluating performance. It may cause ESG investing portfolios’ returns to diverge from the broad markets at times. For example, ESG portfolios may lag when smaller, more value-oriented, less-profitable stocks lead the market—or they may hold up better during times of crisis.

Our latest portfolio research finds no evidence of outperformance when incorporating ESG criteria into an investment strategy. But at the same time, we find no meaningful underperformance either (at least on average), which is good news for investors with strong ESG preferences.

If you’re interested in learning more about ESG investing options, consult your financial advisor about the ways incorporating ESG might affect your factor exposures and what that could mean for your portfolio.

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Investment Factors and ESG Funds

Learn how ESG strategies might affect your factor exposures.

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Footnote

*There were significant variations in investment factor exposures between active and passive funds. Talk to your financial advisor about how you might address your unique preferences in your portfolio.

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Disclosures

This document is a general communication being provided for informational and educational purposes only and is not meant to be taken as investment advice or a recommendation for any specific investment product or strategy. The information contained herein does not take your financial situation, investment objective or risk tolerance into consideration. Readers, including professionals, should under no circumstances rely upon this information as a substitute for their own research or for obtaining specific legal, accounting or tax advice from their own counsel. Any examples are hypothetical and for illustration purposes only. All investments involve risk and can lose value, the market value and income from investments may fluctuate in amounts greater than the market. All information discussed herein is current only as of the date of publication and is subject to change at any time without notice. Forecasts may not be realized due to a multitude of factors, including but not limited to, changes in economic conditions, corporate profitability, geopolitical conditions or inflation. This material has been obtained from sources believed to be reliable, but its accuracy, completeness and interpretation cannot be guaranteed. Northern Trust and its affiliates may have positions in, and may effect transactions in, the markets, contracts and related investments described herein, which positions and transactions may be in addition to, or different from, those taken in connection with the investments described herein.

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