No Surprise: Sustainability Funds Outperform the Market – Despite COVID-19
The megatrend of 2019 was sustainability. Led by climate activist Greta Thunberg, youth across the world demanded politicians and business owners engage in immediate action on climate and sustainability. Investors followed in droves: According to research by Morningstar, estimated net flows into open-end and exchange-traded sustainable funds that are available to US investors totaled $20.6bn for 2019. This was nearly four times the previous annual record set in 2018.
The megatrend of 2020 so far is coronavirus, and with it a tendency to doubt that sustainability will remain a priority. Locked up in their homes and out of their schools, the youth climate movement has come to a near standstill. “Sustainability pays off only in economically rosy times”, we now hear critics say. “As soon as a crisis hits, priority shifts elsewhere.”
But does it really? Have last year’s investments in sustainability-themed funds been a bad idea?
Recent data suggests that the opposite is true. Across the board, sustainability funds have outperformed their peers since the COVID-19 crisis began and across the first quarter, both in developed and emerging markets. Again, figures from Morningstar suggest that in the period through February 28, which saw the biggest downturn in stock prices globally, “the returns of nearly two thirds (65%) of sustainable equity funds ranked in their category’s top half. More than four tenths (43%) placed in the top 25% of their group, and only 10% were in their peer group’s bottom 25%”. Morningstar data also shows that in March, when market activity saw further downturns as countries began to implement lockdown measures, 62% of ESG-focused large-cap equity funds outperformed the global tracker.
Being invested in sustainability appears to pay off, even during a global economic meltdown. But why is this the case?
Let’s explore a couple of approaches:
The first, rather straight-forward explanation for the generally good performance of ESG funds is the fact that they tend to be less exposed to energy-intensive companies, such as oil firms or airlines. These are precisely the industries that have experienced heavy downturns due to lower demand in travel and energy. As MoneyObserver argues, the success of ESG funds to a large degree lies in the stocks they avoid, instead weighted toward low-carbon tech stocks.
A second explanation is the fact that, in order to be eligible for a sustainability-themed fund, a company must be able to report on a vast number of social and environmental performance data points, and it must have a number of strategies and policies in place that protect its workforce as well as the environment. Companies that incorporate these ESG strategies tend to be managed more efficiently and more thoroughly, enabling them to have strong fundamentals that can weather the storm and are a success factor in both good and bad times.
A third clue is that, in our hyper-connected world, investors have increasingly concluded that global crises are deeply related. Whether a company will thrive in the future depends to a large degree on how resilient and agile it is in handling its many stakeholders, global uncertainties, shocks and disruptions – regardless of whether these are caused by a pandemic, social unrest, or an environmental emergency. As Andrew Howard, Head of Sustainable Research at Schroeders, argues, “financial markets no longer exist in isolation from social or environmental challenges”.
Or, as recently reported in the Wall Street Journal: “The pandemic has demonstrated on a large scale the importance of other factors that are paramount to ESG investors. Among them: disaster preparedness, continuity planning and employee treatment through benefits such as paid sick leave as companies direct employees to work from home.”
As 2021 approaches, when young people are finally allowed to gather again for their next climate strike, they will be able to chant one additional line: “Climate action for our future – and for the future of our pension funds!” It turns out, being climate smart also means you’re business-smart. Climate activists and investors alike will increasingly demand bold corporate action on sustainability in the years to come.