As ESG funds are relatively new, the Coronavirus crisis provided a very good test case for studying their behavior in situations of economic shock. Numerous articles and dossiers have been produced to analyze the situation on the markets. We have studied 14 of them to highlight the trends and reasons why ESG portfolios have outperformed their benchmarks. Exclusion and fund selection policies are the reasons often cited for the outperformance of ESG funds, but this crisis has also highlighted the importance of Pillars S (social) and G (governance), or investors' "long-term" objectives.
The exclusion strategy consists of excluding from an investment portfolio sectors or companies that do not meet specific ESG criteria. This is the main reason cited in half of the documents studied to explain fund outperformance. In particular, the exclusion from portfolios of certain sectors such as energy and commodities is cited as the main reason. These sectors were at the forefront of the decline in activity linked to the various lockdowns. The example of the fossil fuel sector speaks for itself: the near-generalized lockdown caused by the pandemic led to a considerable drop in demand, and therefore in oil prices... AXA IM has shown that an equity portfolio applying exclusion policies outperformed the parent benchmark by an average of 47 basis points[1].
However, exclusion was not the only reason for outperformance during the crisis. In two-thirds of the articles analyzed, the reason for outperformance cited was the selection of more sustainable companies in the portfolio. The more funds were exposed to sustainable companies, the greater the outperformance versus the benchmark (a contribution of 45 bps of outperformance in the US, 144 bps for developed markets outside the US and 105 bps for emerging markets).
ESG funds also tend to overweight their exposure to sectors that have weathered the crisis better, such as healthcare and technology, and underweight sectors that have been harder hit, such as transport, energy and materials. While the MSCI World index fell by 14.5% in March 2020, 62% of large-cap ESG funds outperformed the index.
The covid crisis was yet another reminder of the importance of corporate governance and social responsibility. The way companies treated their employees made the headlines. Indeed, some companies were praised for the way they managed their staff during the crisis, or cut executive salaries to sustain their business. In a survey of UK independent financial advisors (IFAs) by asset manager Federated Hermes, over three-quarters of respondents felt that investors would be willing to part with companies that failed to support their employees or society in general during the crisis.
The resilience of ESG funds compared with conventional funds has led to a major "reappraisal" of social and governance issues in ESG ratings, highlighting the importance of these two pillars, which are sometimes sidelined in the face of the ubiquitous climate challenge. Companies with good customer relations or a strong corporate culture deliver solid financial performance. Resilience is stronger for criteria deemed important in times of crisis, with governance issues such as board effectiveness and stakeholder issues such as customer relations showing relatively higher added value during this period. (Blackrock chart appendix A)
This analysis shows the importance of an intelligent mix of environmental (energy demand, pollution, etc.), social (working conditions, etc.) and governance (pressure on the balance sheet) factors in an extreme scenario. The crisis has demonstrated the influence of these extra-financial factors on a company's competitive position.
The final area of analysis does not directly concern investors' strategy, but their behavior. Investors who take ESG criteria into account are part of a long-term objective, which explains why there has been less disinvestment from sustainable funds, and why investors, out of "loyalty", are holding on to their positions. ESG criteria are playing an increasingly important role in investment decisions, and their proven resilience during the Covid-19 crisis can only play in their favour for the future. ESG funds have thus been seen as "safe havens".
Amundi analyzed investment flows into 1,662 ETFs listed on the US market, including 75 ESG-rated ETFs, 24 specialized in environmental issues (low-carbon, water, clean energy, etc.), 53 specialized in healthcare and 30 in technology. Unlike traditional funds, ESG funds did not suffer massive disinvestment during the Italian lockdown, and were not used by investors as an adjustment variable during the turmoil of the crisis.
However, to have a relevant ESG strategy in line with investors' values, you need to start by choosing and finding the right data provider. An analysis[3] by MIT showed that in a set of ESG ratings from five different raters, the correlation between the scores of 823 companies was on average 0.61. This means that "the information decision-makers receive from [ESG] rating agencies lacks consistency", says the paper. Outperformance is therefore not guaranteed, and the challenge is to accurately measure the material ESG impact on company strategy. At WeeFin, we support investors in defining ESG criteria in line with their financial strategy, notably through our ESG Access platform.
