How Sustainable Funds resisted better than others

How Sustainable Funds resisted better than others during last quarter!

Crisis periods like the current one due to Covid-19 increase uncertainty on markets and make investors move to safer assets, with the US dollar, the Swiss Franc or the Japanese Yen among others. In addition, this crisis reduced the demand for oil in a context of a Russia-Saudi Arabia price war that drove oil price to around $20.

When Wall Street just recorded the worst quarter since the fourth quarter of 2008, Environmental, social and governance (“ESG”) investing proved to be more resilient and stayed favorite among investors. Ishare ESG MSCI USA Leaders ETF lost 18,9% this year compared to a 23,5% loss in S&P 500. The pandemic is also a good test for many ethical funds and looking at their performance during this critical period may shape investors tolerance for them in the future.

Of course, sustainable equity funds suffered large losses during the first quarter of 2020 because of the coronavirus pandemic, but they held up better than all equity funds. And being not an asset class of their own, they invest across all capital markets as their respective equity funds. In the first quarter 59% of US ESG ETFs beated S&P500 and 60% of European ESG ETFs outperformed the MSCI Europe Index.

During the first quarter, the returns of sustainable equity funds were in the top of their respective categories, and more sustainable funds’ returns ranked in their category’s best quartile than in any other quartile. The situation looks even better for sustainable index funds investing outside of the U.S, in developped markets as well as in emerging markets.

The better relative performance of sustainable funds in the first quarter comes from their focus on companies that have stronger ESG profiles/lower ESG risk and, secondarily, from their tendency to be underweight energy.

Sustainable funds were helped by having less exposure to energy sector than market indexes. Energy stocks fell more than those of any other sector during the last quarter. Technology had also some impact on sustainable-fund outperformance but a much smaller one than energy, despite the fact that sustainable funds were generally overweight it, due to a much smaller weighting compared to those markets’ indexes.

The biggest reason for their outperformance is that sustainable funds had benefited from their ESG screening and analysis. The companies selected with these criteria tend to be companies that attend to their environmental challenges, treat their stakeholders well, and govern themselves in an ethical way. Such companies are proving to be more resilient during the sudden crisis as they are the quality companies which tend to hold up better than their lower-quality counterparts in difficult markets. ESG leaders have seen so far smaller earning per share (EPS) cuts that ESG laggards.

Most of the growth of sustainable investing has taken place since the global financial crisis, much of it in just the past five years. The magnitude of the stock market decline in the first quarter represents the first stress test of a bear market and they have proved to be decent performers. ESG ETFs had lower outflows in the last month compared to record outflows from equities overall.

Sustainable investing, thanks to ESG analysis, is to deliver financial performance but it’s also to move toward a more long-term stakeholder-centric model of corporate behavior. That longer-term impact, and no more short-term oriented performance, is the key factor behind sustainable investing.

Although none of us know how this crisis will impact our lives in the longer term, we can be sure that it will. And it will be exactly the same for companies and investments.

Remote Access has been tested successfully by many companies, using technology to bring their teams together, with Microsoft Teams or Zoom for example. While some companies downsize, others such as IT and Telecoms sectors experienced already greater demand for their products and services.

Another impact of the virus is the on-discussing positive environmental effects. Many countries report less pollution, returning wildlife and less energy consumption. We have all in mind these pictures of current pollution compared to the same situation last year.

The clear need of medical and emergency, and staffing for health and community care services equipment are another lessons to learn from this crisis. Which will clearly support the Healthcare sector, as the funding will go into research and development of medical products.

The performance of any investment fund should not be judged on a short-term basis, but many ethical ETFs have outperformed their traditional peers in the recent downturn, especially in risk/return perspective. Now, it will be interesting to see how they perform in any economic and financial market rebounds.

And let’s keep in mind that Sustainable Finance is now a clear trend. About 30% of respondents expect to invest between 11% and 20% of their portfolio in ESG ETFs within the next five years, based on a BBH’s survey. And about 95% of Millennials intends to be socially responsible while making investment decisions.

Charles Lamoulen,

Head of Portfolio Management, FIA Asset Management