{"id":46383,"date":"2020-11-05T06:53:53","date_gmt":"2020-11-05T11:53:53","guid":{"rendered":"https:\/\/www.riacanada.ca\/?p=46383"},"modified":"2020-11-05T08:47:34","modified_gmt":"2020-11-05T13:47:34","slug":"why-esg-portfolios-have-proven-resilient","status":"publish","type":"post","link":"https:\/\/www.riacanada.ca\/wordpress\/magazine\/why-esg-portfolios-have-proven-resilient\/","title":{"rendered":"Why ESG Portfolios have Proven to be More Resilient in the Context of COVID-19"},"content":{"rendered":"

If a key investment story of 2020 is COVID-19 and the disconnect between manic markets and a traumatized global economy, a less dramatic but financially urgent sequel to that story may focus on heightened market volatility and the search for more resilient investment solutions. Environmental, social, and governance (ESG) investing has emerged as a key method for pursuing such portfolio resilience, particularly in the context of proliferating economic and systemic social risks.<\/p>\n

ESG investing and the pandemic<\/h2>\n

At the onset of this year\u2019s pandemic-driven volatility, signals of ESG-related strength were widely noted, both at the company level and in ESG-focused equity investment strategies. For example, a Harvard Business School working paper<\/a> released in April documented how companies that the public perceived as behaving more responsibly during the March downturn had less-negative stock returns than their competitors.[1] And in a widely cited U.S. mutual fund industry study<\/a>, fund rating agency Morningstar remarked that \u201c4 times more sustainable funds finishing in the best quartile than in the worst quartile of their categories\u201d during the first quarter.[2]<\/p>\n

Sustainable equity funds performed well during the crisis<\/h4>\n
Q1 2020 return rank % by Morningstar category quintile<\/h5>\n

\"\"What was the key to this resilience? One reason is a widespread energy sector underweight among ESG investment approaches. As COVID-19 dealt a serious blow to the near-term prospects for global economic growth, that helped trigger an oil price collapse and major volatility across the energy sector. A structural view against the future prospects of traditional energy companies, it appeared, helped the performance of a broad swath of ESG funds versus their traditionally managed peers.[3]<\/p>\n

Beyond the cautious sector view, the Wall Street Journal<\/a> noted in late March that ESG factors, particularly social factors, could become more important at the corporate level as investor interest in companies\u2019 approach to human capital management grew more urgent.[4] And as Morningstar\u2019s Head of Sustainability Research for the Americas John Hale declared, ESG strategies appeared to be notably consistent outperformers because they tended to pursue the \u201cquality companies of the 21st Century,\u201d with a focus on \u201cselecting stocks with better ESG credentials.\u201d[5]<\/p>\n

In this moment, ESG factors showed their close alliance\u2014even an identity\u2014with the most operative contemporary definitions of quality. Notably, though, this isn\u2019t quality conceived as a history of profitability, but quality associated with a mix of quantitative and qualitative signals of sustainability, particularly factors that have often been called nonfinancial, intangible, or prefinancial.<\/p>\n

In times of crisis, the prefinancial costs can become financial\u2014sometimes, materially so\u2014flipping the script of materiality and displacing other factors that might formerly have been deemed to have a greater impact on a company\u2019s bottom line. One of the questions we face now concerns whether this reshuffling of factors on the basis of their materiality requires a tactical or a more strategic shift in investment approach.<\/p>\n

The pandemic and the proliferation of social risks<\/h2>\n

As the pandemic has progressed, it appears that companies with a stronger ESG proposition seemed better prepared to weather the economic storm that no one projected would happen,[6] not to mention the social unrest that soon followed. Surfacing a range of systemic social risks, the pandemic has underscored the fragility of economic structures in relation to social factors.<\/p>\n

According to some observers, ESG strategies have maintained an edge through 2020\u2019s market dislocations because they\u2019ve taken a long view on what counts as a sustainable investment across sectors. Banks and other institutions that formerly downplayed the significance of ESG investing have consequently developed a keen interest in sustainable investment characteristics.[7] We think this set of key characteristics is a dynamic but finite set of interrelated ESG factors.<\/p>\n

Some ESG factors that we believe are most relevant to our investments<\/h4>\n

\"\"<\/p>\n

An ESG strategy\u2019s potential for outperformance, moreover, rests on its practice of modeling different scenarios of deterioration or strength. That can mean anticipating the consequences for corporate health in the context of varying climate scenarios or the degree of positive or negative momentum due to changes in social conditions. While the social factors at issue in the pandemic have varied by region and time frame, the social factors we\u2019ve observed as being the most material for the greatest number of companies include health and safety, labor relations, and respect for the community.<\/p>\n

Health and safety: public health structures under pressure<\/strong><\/p>\n

Health and safety are at the center of the pandemic\u2019s swirl of uncertainty. In March, market participants of all levels of sophistication suddenly found themselves grappling with personal and community-focused health questions that could have profound consequences for their lives, livelihoods, and investment portfolios:<\/p>\n