- Sustainable funds have performed better than their peers this year as COVID-19 upended markets.
- Sustainable funds are underweight energy, overweight technology and companies that take ESG criteria into consideration tend to be more resilient, according to Morningstar.
- U.S. sustainable funds experienced a record inflow during the first quarter, despite equities descending into bear-market territory in March.
While COVID-19 sent financial markets reeling, investors in sustainable funds are doing better than those who put money in their conventional counterparts.
The flow into funds taking environment, sustainability and governance issues into consideration climbed to new highs in the U.S. this year, even as the coronavirus outbreak sent equities tumbling. This is uncharted territory for most ESG investors because the sector was in its infancy during the last global recession in 2008.
Sustainability and investing during COVID-19 were explored by Jon Hale, Morningstar’s head of sustainable investing research, and Doug Morrow, Sustainalytics’ director of portfolio research, in a Morningstar webcast last week.
“Funds that had better sustainability ratings had better returns during 2019 in that very strong up market” and then lost less in the first quarter when the market dropped, Hale said. “That’s the story on the fund side of things, ESG demonstrating it can generate returns in both up and down markets and really, for the first time, proving itself in a serious market downturn.”
Investors might have to wait for a rebound, according to Jerome Powell, the Federal Reserve chair. The U.S. economy might suffer “lasting damage,” Powell said on “60 Minutes.” It might take until 2023 for the global economy to return to its pre-coronavirus level, International Monetary Fund Managing Director Kristalina Georgieva said at a May 15 Politico virtual event.
The IMF is predicting a 3% contraction in the global economy this year, compared with a 0.1% contraction in 2008 during the financial crisis.
Companies that take ESG factors into consideration as they respond to the economic downturn may be better positioned during the rebound, Morrow said. Companies that let go of workers, especially in technology, might find it hard to hire skilled employees. Supply chains will also have to be examined for ESG risk, with issues other than cost coming into focus, Morrow said.
“We think the COVID-19 pandemic is likely to lead to even greater emphasis on ESG issues and risk management by investors and management teams,’’ Morrow said. This is in part due to better performance, “but it’s also something we argue is a bit more general. The pandemic has brought to light, and catalyzed, the tension around issues such as biodiversity loss and urbanization, and employee relations and climate change. Some of these issues were in fact drivers behind the pandemic itself.”
There’s no one reason for the better performance of sustainable funds, but a combination of factors, according to Hale and Morrow. ESG funds tend to have less exposure to energy stocks, which was a help during the first quarter when prices plunged. They also usually have greater exposure to technology equities, but that doesn’t explain their better performance, Hale said.
“Sustainable funds are underweight to energy and overweight to technology, but that was only part of the story, it really had more to do with what I call ESG stock selection,” said Hale, adding that investors are using ESG criteria “as a way to evaluate risk that doesn’t show up in company financial statements.”
The number of American ESG funds, and the total amount of assets they manage, is dwarfed by their European counterparts, but interest in sustainability is picking up on Wall Street.
“U.S. funds have been starting to catch up a bit — they captured about 23% of the flows in the first quarter although only about 9% of sustainable funds globally are U.S.-domiciled,” Hale said. “They set an all-time monthly record in April. U.S. funds and their ability to attract assets has continued to grow.”
Hale and Morrow agree that the outlook for companies and funds that take ESG criteria into consideration are better set than their peers to ride out this crisis and profit during the rebound.