ESG-outperformance in a virus-infected bear market
In our latest blog post, written by Mikkel H. Hansen, we touched upon the indication that ESG stocks seems to outperform its benchmarks in the long run, hence sustainability does not equal lower long-term returns. It is a bold statement, so we decided that we want to follow up continuously to analyze whether this statement can be restated or if it has to be rejected.
We have seen quite a shock to the global economy due to the current corona-virus spreading across the globe, which has likewise caused a strong reaction from the financial markets. So, the question is: Is it possible to see a discrepancy in performance between stocks performing good on ESG-factors and standard stock-market indices during the current bear market?
toxic headwinds during q1 2020
Research from Blackrock Investment Institute[1] suggests that stock with higher ESG-scores are typically stocks inhabiting low volatility attributes. Therefore, it might suggest that high-achievers among ESG-factors can add resilience to your portfolio of stocks – and thereby might perform better during a shock like the one we have seen in the latest month and a half.
Another reason why ESG-stocks might perform better is because stocks, that perform well on ESG-parameters, usually possess a higher degree of disclosure of their supply chain. As a result, investors will have a clearer picture of the business they are investing in, putting them in a favorable position to assess important risk factors such as the effect of oil-price fluctuations on earnings. By obtaining this transparency, investors are more likely to choose these in favor of less transparent companies.
Just as we were starting to see the impact on financial markets of the outbreak of the coronavirus, another event caused the markets to drop as well; Russia and the OPEC countries failed to reach an agreement to cut supply of oil, leading to a large drop in the oil price. Just as you might expect that this would reduce the cost of doing business for companies, hence increasing profitability, which would eventually reflect in stock-prices, just the opposite was the case. The plummeting of oil-prices increased the uncertainty and spooked investors, causing the renowned fear-index; CBOE Volatility Index (^VIX), to soar 30% in only one day. While ESG-stocks typically have a low exposure to fossil-fuels, it remained clear that oil-related stocks were not the only stocks affected by this event.
sustainable investments performance in changing markets
When looking at data for the year-to-date development of the MSCI ACWI Index and the MSCI ESG Leaders Index in fixed currency, it is clear that there is a notable difference in the return, in fact the ESG Index outperformed its relative benchmark by 1,34% in the first quarter of the new decade.
For simplicity, and I know it might not exactly be in line with the formal definitions, I will call the period from the 1st of January 2020 until the 20th of February 2020 for the “bull-market” and the time from the 20th of February 2020 to the 31st of March 2020 for the “bear-market”.
However, what also comes clear from the graph, is the fact that already during the bull-market, before the world experienced the rapid outbreak of Covid-19, the ESG Index were already leading with 0,91% or 91 basis points against the broader equity index. This suggests that the majority of the outperformance was generated before the crisis spread across the globe, which is why I tried to index the development to the 20th of February, where we saw the start in the global spreading of Covid-19 and the start of the bear-market.
What becomes clear for me from the graph above are the following: I can partly confirm my initial hypothesis stating that a part of the outperformance was generated during the bull-market. However, what becomes clear from the analysis is that, while it is only possible to observe an outperformance of 61 basis points during the bear-market – which could suggest that ESG-leaders have outperformed less during the bear market – we must consider the time-factor.
Taking an average outperformance per day during the bull market and comparing it to the outperformance per day in the bear-market, the ESG-leaders outperforms with 1,47 bps/day during the bull-market and 2,12 bps/day in the bear-market. While we are down to the 3rd decimal on a percentage-point, if not to use the word significant, I would still call this a notable difference. However, the data-set is limited, so I am cautious in drawing any vague conclusions here, so what I will go with for now is that it seems like ESG-leaders are outperforming more during bear-markets than during bull-markets.
As previously mentioned, the analysis is limited on data, which makes it impossible to conclude that sustainable investments clearly outperform its relative peers during a bear market, with certainty. While the data suggests a small outperformance, it remains clear that investing sustainably will most likely not compromise returns. So, whether it was investors’ clearer picture of risk or the general less volatility of ESG-stocks, that caused this performance, remains unclear. Overall, what can be drawn from the analysis is that, even when we face bear markets, sustainable investing continues to be an objectively rational good decision – which even rewards investors for good-conscience-decision-making.
Article by Magnus Trampe Broch
CBS Sustainable Investment Club
At CBS Sustainable Investment Club, we believe in the benefits of sustainable investing. We believe that incorporating material environmental, social and governmental (ESG) information in investment practices leads to better informed investment decisions and as a result better long-term performance. To this end, we at CBS Sustainable Investment Club aim to deliver knowledge and expertise about sustainable financial solutions to the CBS student body and to broaden the understanding of how sustainability is integrated into financial services, markets and the general economy.
Sources:
[1] https://www.blackrock.com/us/individual/literature/whitepaper/bii-sustainability-future-investing-jan-2019.pdf
Disclaimer
Investing involves risks. This material is not intended to be relied upon as an investment advice, and is not a recommendation to buy or sell any securities or to adopt any investment strategy. Each investor shall make his/her own investment appraisal.
This post may contain “forward-looking” information such as, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader. And remember, past performance is no guarantee of future results.