End of Week Notes
Why the pandemic will hasten the growth of sustainable investing
The current crisis is affecting sustainable investing in at least three ways. First, sustainable funds are proving themselves to be resilient in a down market, something many of them hadn’t had an opportunity to do prior to the pandemic. Second, the focus on corporate responses to the pandemic is creating greater appreciation for the importance of the “social” dimension of ESG analysis. And third, the crisis is hastening the move toward a stakeholder model. These three factors seem likely to support the continued growth of sustainable investing.
First, the pandemic has given sustainable funds the chance to prove themselves in a down market. Funds with a focus on ESG and/or impact have demonstrated their resilience relative to most conventional funds, at least so far, during the COVID-19-induced downturn.
Through the end of 2019, sustainable funds had shown they can deliver competitive performance during normal up markets, but the jury was still out on bear-market performance. Not that many sustainable funds were around during the financial crisis and so hadn’t experienced bear-market conditions, much less economic-crisis conditions.
Here is how sustainable funds looked relative to their peer groups at the end of 2019:
The exhibit shows that sustainable funds were over-represented in the top quartiles and top halves of their Morningstar categories based on their three- and five-year trailing annualized returns. So far, so good.
The following exhibit shows the same comparison for this year through April (equity funds only):
So far this year, 70% of sustainable equity funds have returns that land in the top halves of their Morningstar categories, and the ratio of top-quartile to bottom-quartile rankings is 43:11.
Furthermore, this is important not so much because the actual returns of sustainable funds were massively different from those of conventional funds — they weren’t — but because the outperformance of equity funds appears to be attributable more to their emphasis on companies with stronger ESG credentials than just a happy coincidence of their sector weightings. While energy underweights helped during the first quarter, ESG stock selection was the biggest positive factor, especially outside the U.S.:
A second effect of the pandemic on sustainable investing will be a greater appreciation of the “S” in ESG. Company policies and treatment of workers, customers, and communities is what the “S” in ESG is all about. Most professional ESG analysis emphasizes these areas particularly in industries where they are most material to financial performance, but many end investors have the impression that sustainable investing is mostly about the “E” in ESG, especially climate change.
The pandemic has forced companies to focus on their workers, customers, and communities and their actions are being closely scrutinized in media and by organizations like JUST Capital, which has developed a COVID-19 corporate response tracker.
JUST Capital also found that firms that it assesses as doing the best job prioritizing workers outperformed those doing the worst by 7.3% in the first quarter.
When companies do things like increase healthcare benefits, hike pay for workers on the front lines, lower executive compensation to help avoid layoffs, and take extra steps to protect worker and customer safety, they will benefit from having a more-engaged and productive workforce and a more-loyal customer base during a recovery.
By putting the spotlight on company’s treatment of workers, customers, and communities, the pandemic is helping advisors and their clients understand that sustainable investing extends beyond environmental considerations.
Finally and bigger picture, the pandemic seems likely to hasten the movement toward stakeholder capitalism. That means a shift away from a narrow focus on short-term profit maximization toward long-term value creation that benefits all stakeholders. We may see support for this from policymakers, as they consider whether to limit share buybacks, add employees to boards, or limit executive compensation.
But I think the existential crisis of the pandemic itself will sway more companies towards a stakeholder model. Many will realize a focus on stakeholders is what helped them survive the crisis while the recovery will encourage a “we’re all in this together” ethos. Post-pandemic, public expectations for corporate purpose and responsibility will be heightened.
Sustainable investing, as I’ve argued before, has a major role to play in helping companies move toward a stakeholder model. The more corporate CEOs see their shareholder base as supportive of such a move, the more likely it is to happen.
As a result of these factors, I think we’ll continue to see assets pour into sustainable funds. The intermediary and advisor pinch points will be further relaxed, with fewer attempting to wave interested clients away from the idea, and more recommending sustainable investing as an appropriate way to manage risk.
The pandemic hasn’t put much of a dent in sustainable fund flows so far. After a record quarter for flows in Q1, I expected April to be slow-going for sustainable funds, but instead, an estimated $5.7 billion flowed into sustainable funds in April, an all-time high for a month.
Navigating Investing During Novel Coronavirus: Sustainability and ESG Risk
I want to thank the hundreds of you who attended our quarterly ESG webinar on Thursday, and to thank our special guest, Martin Whittaker, CEO of JUST Capital.
This coming Thursday, May 14, 10 a.m. CT, I will be joined by my new colleague from Sustainalytics(!), Doug Morrow, director of portfolio research. This session will focus on what has shaped results for sustainable strategies during this market downturn and the ways in which an ESG risk lens can contribute to our understanding of company resilience.
During this webinar, we will cover:
- An overview of the ESG landscape, fund performance and flows
- Company-level impacts across value chains and industries
- How the pandemic has further emphasized the materiality of ESG-related risk
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