Is it too early to ‘claim victory’ for ESG in the pandemic?

Rathbones’ Matt Crossman considers the outperformance of funds with a focus on ESG factors.

With the world in lockdown and experiencing the worst recession in living memory, was the recent trend towards Environmental, Social and Governance (ESG) a luxury afforded by the longest bull market in living memory?

In 2008, as a 20-something postgraduate student in “voluntary isolation”, holed up with my parents while I finished my studies, I was on leave from a fully fledged career, with a job to return to...or so I thought. The day before my final exam, Lehman Brothers collapsed. I’d focused on ethical and sustainable investing; would I have a career to go back to?

Back then, the knives were out for nascent ESG funds, and the well-worn argument for investing in traditional, defensive stocks still echoes today: “invest in stocks that have steady demand”. That means alcohol, tobacco, and arms companies, whose priorities are set by government policy not the vagaries of the market.

For the income-seeking investor, it was a case of “any port in a storm”, whereas now people may be seeking “any dividend in a pandemic”. Then as now, “values” are seemingly in conflict with seeking value. Can we afford to push responsible capitalism in the current environment?

It won’t come as a surprise to learn that we think we can and should. It’s clear to us that a more responsible form of capitalism could have prevented the worst impacts of the Covid-19 pandemic. The warning signs about the vulnerability of our globalised world were there for everyone to see. Bill Gates, one of history’s greatest capitalists, was sounding the alarm: “If anything kills over 10 million people in the next few decades, it's most likely to be a highly infectious virus rather than a war. Not missiles, but microbes…We're not ready for the next epidemic.”

He went further, noting that we had all we needed to be better prepared – the technology, the building blocks of a response system – but not the will to spend a little to save millions.

Our healthcare system is beset by incentivisation issues and has seen more than its fair share of ethics and bribery scandals. The private sector has little motive to invest in researching goods that might not be immediately lucrative, its focus has been on lifestyle drugs instead.

We need coordinated investment in the continued development of antibiotics. Although governmental will was lacking here too, the private sector could have rallied around these calls and built more resilience into the system. But would their shareholders have encouraged it? If companies took the sustainable development goals (SDGs) as seriously as their next quarterly earnings report, could the world be a more resilient and prosperous place by 2030?

Outperformance

The immediate impacts of this particular crisis have been kinder to ESG-themed investments. According to Morningstar data, while the MSCI World index fell by 14.5% in March, well over half of global large-cap funds with a focus on environmental, social and governance (ESG) factors outperformed their benchmark.

Much of this outperformance can be explained by the sectoral exclusions applied by most ESG funds, especially those excluding oil and gas companies, which have been hit by a double whammy of Covid-19 and a price war. But for many of these funds, avoidance of oil and gas was not accidental; it was built on a solid analysis of how climate change action could destroy demand for their products.

Furthermore, a focus on what a more connected, clean-tech driven future might look like has increased ESG funds’ exposure to the kind of industries doing well in the “new normal” of 2020. Video-conferencing, remote-working, online teams and networking were all touted as industries of the future and most ESG funds were more heavily weighted to these areas. So far, these sectors haven’t just survived, they’ve thrived.

It’s too soon to claim “victory” for ESG, but the initial returns suggest a longer-term and more holistic approach to risk has insulated ESG funds from the worst impacts of Covid-19 and global lockdowns.

In analysing why ESG-conscious companies have done well, it’s helpful to make the distinction between those trends caused purely by the pandemic, and those accelerated by it. Short-lived supply chain failures of basic goods, for example, or the sudden cut in transport activity will likely bounce back. But in other areas, Covid-19 has sped up the evolution and maturity of trends towards a more sustainable and responsible capitalism that were already visible.  

Matt Crossman is stewardship director at Rathbones.