Environmental, social and corporate governance (ESG) factors can have a positive impact on portfolio returns, according to a growing body of academic research.

A report* published yesterday by investment consultancy Mercer analyses 16 academic studies, 10 of which show ESG factors have a positive impact on companies' financial performance, four a neutral impact and two a neutral-to-negative impact.

"The idea that responsible investment does not have to come at a cost to performance is becoming well established in the institutional investment industry," says Tim Gardener, global chief investment officer for Mercer's investment consulting business.

The company says a report** it published in October 2007 with the United Nations (UN) Environment Programme Finance Initiative helped dispel the preconception that integrating ESG factors into investment analysis and decision-making leads to financial underperformance. And the new document presents a summary of some of the new academic studies carried out in this area since then.

One conclusion Mercer makes is that factors such as manager skill, investment style and time period are integral to how ESG factors affect investment performance. As a result, taking such factors into account will not necessarily have a uniform impact on portfolio performance; Mercer expects "significant variation across industries".

The report broke down findings separately into environmental, social and governance conclusions. With regard to environmental factors, one study published in 2007 found that only 35% of financial analysts' reports in Europe and North America contained environmental information.

Findings from studies of social factors included that racial diversity can positively affect intermediate and long-term financial performance. Adding microfinance investment funds to a portfolio can also improve returns, found two studies. Overall, the social-factor research suggested that improved social performance of companies in a portfolio can lead to better returns.

The studies on governance showed, perhaps not surprisingly, that strong corporate governance has a positive impact on firm and portfolio performance. Another recent Mercer report looked at corporate governance among Chinese resources companies, which concluded that they need to do more in this area, and that doing so would benefit their shareholders.

It does not help the case for responsible investing that some evidence shows that companies are not uniformly disclosing comprehensive information about ESG factors. Over the long run, says Mercer, comparable and reliable reporting standards in this area will form an important part of making ESG-related investing a more mainstream practice.

Another point the company noted is that most studies to date focus on the link between ESG factors and listed equity assets. However, this is starting to change, says Mercer, which has included analysis of microfinance in the report.

Meanwhile, Asian signatories to the UN-backed Principles for Responsible Investment are steadily increasing, led by Japan (with 12 signatories) and South Korea (with nine signatories), notes Helga Birgden, Mercer's Asia-Pacific head of responsible investment. This indicates that Asia-based managers are starting to catch up in integrating ESG factors into their investment processes, something others have also pointed out.

* Shedding light on responsible investment: Approaches returns and impacts, November 2009.
** Demystifying Responsible Investment Performance, October 2007.