End of Week Notes
On ESG and financial performance
Sustainable investing can help investors reach their financial goals while also having a more positive impact on the world.
Investment performance is one of the reasons why more assets are flowing into sustainable funds. As more sustainable funds have built good performance records, lingering doubts about their ability to deliver competitive returns have diminished. This is especially important to financial advisors who do not want to steer their clients into underperforming investments.
Over the past several years and especially in 2020, sustainable funds have outperformed their conventional peers. The better relative performance is tied to their emphasis on companies with better ESG profiles and their thematic alignment with the accelerating transition to a low-carbon economy. In 2020, sustainable funds demonstrated that investing with an emphasis on how a company manages material ESG risks and how it manages key stakeholders can produce better returns in an uncertain economic setting.
From my recent, Sustainable Funds U.S. Landscape Report, here is how U.S. sustainable funds stack up with their peers on a trailing 1-, 3- and 5-year basis:
In a nutshell, sustainable funds are over-represented in the higher quartiles and under-represented in the lower quartiles. (Compare the top-to-bottom ratios, or the top half-to-bottom half ratios.)
At the beginning of 2020, I selected 23 ESG index funds (12 US, 11 non-US) and followed their performance, quarter by quarter. (Links: Q1 Q2 Q3 Q4.) For the year, 22 of the 23 ESG index funds outperformed the relevant conventional index fund with which they were compared. The 15 ESG index funds in the group with three-year records are all outperforming over that time frame as well. (By the way, the only “underperformer” lagged by just 0.1% in 2020.)
All in all, a pretty good showing for sustainable funds. Keep in mind, however, that all sustainable funds are not taking exactly the same approach. In a Consultation Paper released last August, the CFA Institute identified six distinct “ESG-related features” that may be part of an ESG strategy:
- ESG integration
- ESG-related exclusions
- Best-in-Class
- ESG-related thematic focus
- Impact objective
- Proxy voting, engagement, and stewardship
A given sustainable fund may employ one or more of these features; some may even use all six. Moreover, each “ESG-related feature” may be employed to a greater or lesser degree. For example, a strategy may use one exclusion or many; its best-in-class criteria may be relatively loose (avoid laggards) or tight (focus on leaders), and so on.
What do academics have to say on the topic? Last summer, I commented on several studies that came out in 2020 specifically tied to ESG fund and corporate resilience amid the global pandemic.
Now comes a new meta-study from the NYU Stern Center for Sustainable Business and Rockefeller Asset Managment summarizing academic work published in the last five years about ESG and financial performance.
The authors examined articles about corporate financial performance and those about investment performance. Here are the top-line results:
To sum up, the plain empirical evidence on fund performance and the collective conclusions of academic studies should put to rest any remaining pockets of concerns among wealth managers and advisors about underperformance. Beyond that, these findings should give confidence to advisors that investments in sustainability can help their clients reach their financial goals just as effectively as traditional investments while also having a more positive impact on the world.
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Morningstar ESG Indexes outperformed in 2020 and over the past five years, also lost less in down markets
Consistent with the performance of ESG index funds discussed above, the vast majority of Morningstar’s ESG indexes outperformed in 2020, according to my colleague Dan Lefkovitz:
- 52 of Morningstar’s 69 ESG-screened indexes (75%) outperformed their broad market equivalents in 2020;
- 57 of 65 ESG indexes (88%) outperformed for the five years through the end of 2020; and
- 59 of 65 ESG indexes (91%) lost less than their broad market equivalents during down markets over the past five years, including the bear market in the first quarter of 2020.
The impact of Larry Fink’s annual letters
My colleague Jackie Cook writes:
In recent years, BlackRock chief executive Larry Fink’s annual letter to corporate chiefs has become the kind of marquee event in the sustainable investing world that Warren Buffet’s shareholder letters have for years been for the value investing crowd.
She traces the evolution of his annual letters, concluding about this year’s letter:
[H]is much-anticipated CEO letters deserve credit as contributing to the mainstreaming of ESG in investing. Importantly, they’ve also become something of a proxy season kick-off and this year’s letter sets a discernably higher bar for climate-linked engagements ahead of annual shareholder meetings.
