Ethics and alpha: can investing responsibly enhance returns?

Steve Waygood, Chief Responsible Investment Officer at Aviva Investors, makes the case for investing responsibly.

"There is one, and only one, social responsibility of business: to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud."
Milton Friedman, Nobel Prize-winning economist

Friedman, a celebrated free-market economist, described the idea that businesses had a responsibility to society as a “fundamentally subversive doctrine”.1

He wrote a seminal 1970 article for The New York Times Magazine. It sparked furious debate about whether firms can increase their value by incorporating environmental, social and governance (ESG) considerations into their business operations.

While that argument continues to this day, there is a growing body of evidence to suggest they can.

Empirical evidence

An image of skyscraper viewed from street level.

Drawing on an ever-expanding universe of data, researchers have conducted studies to establish whether such a relationship exists.

Researchers at the University of Hamburg and Deutsche Asset and Wealth Management found a positive relationship between ESG ratings and corporate performance in close to half of the 1816 academic studies published since 1970. They found a negative correlation just 10 per cent of the time.2

A July 2013 Harvard Business School study found that over an 18-year period a sample of ninety “high-sustainability” companies “dramatically outperformed” ninety low-sustainability firms in both stock market and accounting measures.3

Logical explanations

There are logical explanations as to why.

Firstly, assets underpinned by high ESG ratings are likely to be less risky. In the short term firms may be able to get away with exploiting their customers or workforce, or the environment. But they will eventually be damaged by such behaviour.

Secondly, there is evidence to suggest highly-rated firms have a lower cost of capital. Several studies have found good environmental performance correlates with a lower cost of debt and stronger credit ratings. One study found the same for good employee relations.

Engage or divest?

Incorporating ESG criteria into the investment process can improve returns in other ways. Since the evidence suggests companies can create value by improving their ESG scores, it makes sense to engage with them to help improve their approach.

A close up of business pages in a newspaper.

Investors may wish to encourage an oil company to improve its safety record to lessen the danger of oil spillages, or reduce the risks it faces due to climate change. Such improvements are likely to be rewarded by the market, even if not immediately.

Having said that, as an investor there’s a decision to be made about how much time and money should sensibly be devoted to engaging with companies. In large part, this is because there is likely to be a ‘free-rider’ problem with other investors potentially benefitting from those efforts. Collaborating with other investors often makes sense.

The trend is clear

The debate sparked by Friedman continues to rage nearly 50 years later partly because his comments have frequently been taken out of context.

In a forgotten part of his oft-quoted article he said the responsibility of a corporate executive is to “make as much money as possible while conforming to their basic rules of the society; both those embodied in law and those embodied in ethical custom”.

However you define it, however you measure its impact, it is becoming extremely difficult to argue against incorporating ESG analysis into the investment process.

While investors need to be wary of overpaying for assets based on ESG criteria alone, there is every reason to believe investing responsibly will pay off.


1 The Social Responsibility of Business is to Increase Its Profits, The New York Times Magazine, September 13, 1970

2 Friede G, Busch T & Bassen A (2015): ESG and financial performance: aggregated evidence from more than 2000 empirical studies, Journal of Sustainable Finance & Investment

3 Eccles R, Ioannou I, & Serafeim G (2011): The Impact of Corporate Sustainability on Organizational Process and Performance, Working Paper Harvard Business School

Steve Waygood, PhD, Chief Responsible Investment Officer at Aviva Investors

Steve Waygood, Chief Responsible Investment Officer

Steve leads Aviva Investors' Global Responsible Investment team, which is responsible for integrating environmental social and corporate governance (ESG) issues across all asset classes and regions of c£350bn of assets under management. The team has achieved an A+ ranking in governance and strategy from the UN Principles for Responsible Investment; a Tier 1 assessment for Stewardship from the UK Financial Reporting Council; and won the Responsible Investment Thought Leader and Innovator of the Year global award in 2017.

Steve is a member of the Chartered Financial Analyst institute, with a degree in Economics and a PhD in sustainable finance. He is a faculty member at the International Corporate Governance Network and the University of Cambridge Institute for Sustainability Leadership. He is also a Visiting Professor of Sustainable Finance at Cass Business School.  


Rob Davies 

James Whiteman

More of our Perspectives