Investments with a sustainable focus better able to weather Covid-19 storm
ESG equity funds have suffered large losses of value this year but have held up better than conventional funds
Environmental, social and governance (ESG) funds favour companies with better ESG credentials that can be expected to manage their environmental impacts, treat their stakeholders well and govern themselves in an ethical way. Indeed, it appears that such businesses have been more resilient during the Covid-19 crisis and are showing themselves to be the new “quality companies” of the 21st century.
In a strange way, the Covid-19 crisis has provided a good litmus test for the quality management argument around ESG investing and further supports the idea that ESG integration is not just a nice to have but it is also a good to have. We have long maintained that analysis of ESG issues can, and does, drive long-run investment performance. We see sustainability as a macro thematic trend that is fundamentally reshaping the competitive landscape across all sectors. Companies that respond to this trend early enjoy stronger social licence to operate, lower staff turnover, better resource efficiency, lower cost of capital, better innovation and stronger access to market.
As a group we have invested in building our product offering to capture this theme through a series of ESG indices. These funds have attracted inflows in a manner that is consistent with the growing global trend. Sustainable investing has grown exponentially in the past five years. For example, in the US net flows into sustainable funds reached $20.6bn in 2019, more than four times the previous annual record set in 2018.
Like all funds, sustainable equity funds suffered large and sudden losses of value in the first quarter of 2020 due to the Covid-19 pandemic. Morningstar reports that sustainable investment funds held up better than conventional funds during this period. In addition, seven out of 10 sustainable equity funds finished in the top halves of their Morningstar categories, and 24 of 26 ESG tilted index funds outperformed their closest conventional counterparts.
An additional point to consider in the “good to have” bucket is that ESG fund flows remain intact. Research from Bank of America Securities indicates that while there has been record exchange traded fund (ETF) selling over the past few weeks, ESG funds have seen inflows for 10 straight weeks. Even after the market sell-off, ESG ETF assets under management are still up nearly 5% in the year to date, while S&P 500 ETFs have seen assets under management decline by over 30%. In Europe, ESG funds have seen persistent inflows, including in recent weeks, even amid EU stock outflows.
As society seeks to rebuild in a post Covid-19 world we expect the idea of green growth to continue to gain traction. The notion of green growth emerged after the last financial crisis and envisages an alternative growth path guided by climate awareness, resource efficiency and social inclusion. At a global level, green growth features in national growth strategies, and the EU is putting in place legislation to drive and incentivise these kinds of outcomes.
At the local level work is being undertaken to develop a green economy taxonomy for SA as a basis for supporting our inclusive growth agenda. As the government struggles with an increasing debt burden we can expect a resurgence of the prescribed assets debate and increasing pressure for all factors in the financial markets to align with green economy outcomes.
Old Mutual has a specialist green economy investment capability, managing some R131bn of client assets in the green economy. It is important to note that given the structure of the economy, accessing green growth assets has required that investors look to the unlisted markets via private equity and infrastructure type funds.
Accessing these investment types has traditionally been the domain of institutional investment funds. Green growth is not only a scientifically bounded economic idea but also a set of globally consistent consumer preferences, as more consumers align with the sustainability agenda. Doing more with less has always been a good idea, as has caring for the environment along with being a good neighbour. As such we expect demand for “green” assets to grow beyond the institutional market to the retail market as well. Asset managers that have green growth capabilities and assets will be at an advantage over their peers as the world seeks to normalise in a post Covid-19 world.
Sustainable investing is about delivering competitive financial returns by leveraging ESG insights. It’s also about shifting the global economy to a path that is low carbon, resource efficient and socially inclusive. Now, during this crisis, is the perfect moment for all actors in the financial services sector, whether they be advisers, consultants, asset owners or asset managers, to realign their understanding of responsible investing and ESG issues.
It’s critical that decision makers are clear on how ESG issues affect long-term risk and returns, and additionally how the growing trend towards sustainable investing affects the ability to attract and retain client capital.
• Duncan is head of responsible investing at Old Mutual Investment Group.
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