Byline on ESG Outperformance in Early Pandemic
[client work]
The novel coronavirus has upended normal life and rattled markets around the world. Without a vaccine, cure, or even realistic reopening of the United States economy in sight, investors are pricing in prolonged uncertainty and negative growth as consumers face restrictions on travel, dining and spending in general. One silver lining for investors, though, would be the relative outperformance of responsible investment strategies during the recent downturn.
According to a Morningstar report, over two-thirds of sustainable equity funds finished in the top half of their categories through Q1, with an additional 44% with returns in the top quartile. Remarkably, only 11% of sustainable equity funds placed in the bottom 25%. Take the Fundsmith Sustainable Equity Fund, which posted a -7.8% figure in Q1 compared to -22% for equities globally, or one of our foundation clients whose impact portfolio posted a -13% return through March 31. Of course, these are diversified well-managed portfolios but they demonstrate the overall outperformance of the impact category compared to equities at large.
Responsible investing strategies are consistently delivering better performance during the pandemic, and it is in large part the result of thematic advantages, as well as idiosyncratic tailwinds from strong governance dynamics.
Thematic Outperformance
The first and most obvious reason that responsible investing strategies have outperformed peers is that portfolios scoring high on ESG have been structurally underweight to carbon intensive industries and traditional energy (which has been doubly-hit because of the OPEC-Russia oil dispute), which helped limit exposure to the worst performers of the past two months; and responsible investing’s focus on quality has prioritized companies with durable balance sheets and sectors such as biotech, healthcare, and information technology. These sectors will be in high demand by an ever-widening audience over the next few years, seeding the ground for strong comparative returns.
In the private markets, thematic opportunities in venture capital-backed companies specializing in educational tools and connectivity software – two areas with exploding customer universes – have proven additive. The prioritization of our environmental and equity lens strategies not only aligned with shareholder values, they’re poised to succeed coming out of this crisis.
Real estate is another sector where impact strategies benefit from inherent downside protection. Impact portfolios typically have exposure to real estate through Section 8 housing which, critically, offers a backstop for a portion of a given portfolio (often greater than 50%, though sometimes less). So, rent cash flows don’t dry up even when renters are unable to pay – a strong assurance in a recession.
Cash, an often-overlooked allocation, is also put to use in interesting and timely ways by responsible investors. Instead of holding cash at large financial institutions that don’t necessarily deploy assets according to a socially responsible lending criteria, impact investors will often turn to community lending across the United States. Leveraging cash distribution tools, they invest in small banks and credit unions which then use the funds to issue loans and support community programs, boosting job growth, infrastructure development, and social services. Such strategies yield similar returns and liquidity as standard money market accounts.
What’s more, the CARES Act has outlined guaranteed SBA and economic disaster loans which will be most effectively facilitated via local lending partners. Top performing responsible strategies are already helping to fund these loans through the cash allocations, battling back against the coronavirus downturn while preserving capital.
Good Governance
In the long term, the story of this crisis and who weathered the storm might come down to governance. The companies that will outperform right now are those that have been well managed and have strong balance sheets with low debt loads. Good governance means flexible leaders who encourage working from home and communicate openly about organizational direction.
Companies that choose to support the coronavirus relief should also see a lasting reputational effect. Louis Vuitton repurposed their perfume plant to manufacture disinfectants, Nike is pumping out face shields and New Balance is sending masks to the front lines. These key decisions to spend money on the greater good will expedite the economy’s recovery and earn the trust of consumers.
The impact of good governance will not play out in a single quarter. It will unfold over the course of 2020 and into 2021, and ESG-aligned managers with a strong focus on governance and quality are poised to capitalize on this trend
Though the entire market suffers from hampered consumer spending (and will likely suffer from a boom in spending cash savings), the future-proofing mindset of responsible investing has proven a good salve for losses. Thematic choices to move away from carbon and lean into socially beneficial assets have been especially fruitful in a world where movement is limited and relying on others has become necessary.
Hopefully the responsible response to COVID-19 is not only effective but may also serve as a blueprint for how countries collaborate on other pressing global challenges, such as climate change and income inequality.