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Will ESG funds surface as the winners of the crisis?

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Without fiscal rescue packages, the coronavirus crisis is expected to have devastating effects on a swath of companies, but could sustainable firms come out better than others?

The International Monetary Fund has predicted that the ‘Great Lockdown’ will cause the worst recession since the Great Depression, and far worse than the Global Financial Crisis, as it projects global growth to fall to -3% in 2020.

However, as companies with high environmental, social and governance (ESG) credentials are supported by wider sustainability trends, it could mean that they have an advantage compared to conventional companies.

The pandemic struck at a time when nations had already been struggling to cope with environmental risks from climate change and issues such as rising inequality.

As a solution, some nations have touted ‘inclusive’ and ‘stakeholder capitalism’ as development pathways going forward, and the crisis could support these sustainability trends.

Sustainable funds have shown resilience

Research has found that ESG funds have beaten conventional funds in the crisis, so far.

According to Morningstar, like all equity funds, sustainable equity funds suffered sudden and large losses during the first quarter of 2020 because of the pandemic.

However, its April analysis showed that the returns of 70% of sustainable equity funds finished in the top half of their Morningstar categories.

Out of 26 ESG-tilted index funds, 24 outperformed their standard benchmarks.

David Winborne, senior portfolio manager, director at Impax, explains that ESG global equity funds have broadly performed well, often because their weightings were lower in the underperforming energy sector.

Other reasons for their outperformance, he told Expert Investor, were “a greater focus on more defensive and resilient sectors such as healthcare and technology” and “superior ESG profiles often demonstrating higher quality operational characteristics, which can protect their business models in economic downturns”.

Anu Narula, head of global equities at Mirabaud Asset Management, says that high-quality ESG companies succeed over the long-term as they create long-term value for all stakeholders.

But he explains that they are also more resilient “as they tend to have lower controversies occurrences, greater customer and employee loyalty, management, and sometimes more conservative balance sheets”.

Past sustainable equity fund flows

The growing sustainability trend has supported ESG funds in the past.

For example, global ESG equity fund flows have surged by 43.7% in assets under management in the category between the start of 2018 and the end of 2019, according to data provider EFPR Global.

This compares to a mere 0.1% of non-ESG global equity funds (see chart below).

Winborne comments that one reason for the increasing flows in sustainable global equity funds is their strong track record of outperformance.

Last Word Research has found that European investor sentiment over the next 12 months towards global equity funds remains broadly the same, with a slight uptick in buying intentions (see chart below).

Emerging ESG trends

While it may be hard to tell if companies with high ESG credentials will turn out as the winners of this crisis, there are signals that they could.

Some argue that, as the bills from fiscal stimulus will be carried by future taxpayers, the recovery should support the sustainable development of companies and benefit society.

Mikhail Zverev, head of global equities at Aviva Investors, says: “More broadly, unprecedented levels of public fiscal and monetary support for the economy may demand reciprocal ‘national service’ from businesses.

“We have already seen this resulting in dividend cuts in the European financial sector, but there will likely be more points of pressure,” he told Expert Investor.

Among other sustainability trends which could come to the fore during the crisis is corporate social responsibility, according to Jaime Ramos Martin, portfolio manager at Aviva Investors.

“Challenging ESG practices like excessive tax optimisation, poor labour and community relations, poor environmental compliance will be harder to defend against public and regulatory attention in the post-covid world,” he says.

Some of the trends that are emerging from the crisis could also harm ESG companies.

In Martin’s view, the biggest risk to ESG companies could stem from the oil price collapse and high government deficits, which could lead to abandoning climate change goals and subsidies for green energy or technology.

But he also says that ESG companies with stronger credentials may benefit from stimulus packages.

Whether these measures will benefit sustainable companies more than others is still unclear.

See also: Where does covid-19 leave ESG? An investment company perspective

The EU has revealed it is currently planning to focus its recovery package on green and sustainable investments.

President of the European Commission, Ursula von der Leyen, said on 28 April that the European Green Deal will be “our motor for the recovery”, according to media network Euractiv.

Investment trend

Despite the oil price crash, investor confidence towards environmental companies seems to be unscathed.

Morningstar found in an April research report that five environment- and climate-related offerings were among the best-selling sustainable funds in the first quarter, totalling €3.5bn in flows.

These are:

  • ACS World Low Carbon Equity Tracker Fund (Blackrock);
  • Global Environmental Opportunities (Pictet Asset Management);
  • Anima Investimento Circular Economy 2025;
  • Eurizon Fund – Absolute Green Bonds; and
  • Nordea 1 – Global Climate & Environment Fund.

“This is testament to the growing awareness among investors of the risks and opportunities arising from climate change,” the report states.

“We expect flows into climate-aware funds to continue their upward trajectory in the coming years, supported by significant regulatory developments, including the EU Action Plan on Sustainable Finance.”

It also noted that despite the market sell-off in March, the European sustainable funds universe attracted inflows of €30bn in the first quarter of 2020, while the overall European fund universe suffered outflows of €148bn.

Winborne sees the transition to a more sustainable global economy gaining pace, accelerated by rising trends in energy efficiency, health food and recycling.

This, he believes, will help sustainable global equity funds to outperform global equities and deliver superior risk-adjusted returns over the long term.

Sustainability trends could help ESG companies to exit the crisis with an upper hand over other firms.

Or, in other words, as populism in the EU has been on the rise, together with increasing inequality, supporting unsustainable trends will become harder and harder for firms to defend.

Elena Johansson

Senior Reporter

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