The pandemic has been described as the ultimate test for the performance of funds that consider environmental, social, governance factors, writes Clifford Fram. The early evidence shows they are outperforming their peers.

Blackrock chairman and CEO Larry Fink had no hint of the impending market turmoil when he wrote to clients and CEOs early this year to tell them about the global giant’s commitment to sustainable investing.

“Because sustainable investment options have the potential to offer clients better outcomes, we are making sustainability integral to the way BlackRock manages risk, constructs portfolios, designs products, and engages with companies. We believe that sustainability should be our new standard for investing,” he wrote.

Subsequent research by Blackrock, AXA IM, MSCI and others shows that 2020 has been a relatively good year so far for sustainable investors that consider environmental, social, governance (ESG) factors.

“It’s become clear that responsible investors are ahead of the game. They are identifying the key themes influencing markets and returns, which helps them to better navigate turbulent times, avoid the biggest risks and capture more opportunities,” says Simon O’Connor, CEO of the Responsible Investment Association Australasia (RIAA).

The association has collaborated with KPMG to publish the Responsible Investment

Benchmark Report 2020 Australia. It shows that in 2019 Australian and multi-sector responsible investment funds outperformed mainstream funds over 1, 3, 5 and 10-year time horizons.

Minimum standard

The report says consideration of ESG factors is an expected minimum

standard of good investment practice, with $1 trillion of Australia’s assets under management using ESG integration as a primary approach. Negative screening is a common strategy, with weapons, tobacco, gambling and pornography top of the list.

The report also shows screening for fossil fuel exposures is gaining traction. In 2019, 19% of responsible investments were screened for fossil fuels, up from 5% in 2018.

Analysis by RIAA shows the outperformance identified in the benchmark has continued amidst the market disruption brought on by COVID-19.

An RIAA paper on the performance of responsible investments during COVID-19 summarises insights from six investment and research houses. This is what they found:

1. BlackRock: Tested its conviction that companies managed with a focus on sustainability should be better positioned than their less sustainable peers to weather adverse conditions while still benefiting from positive market environments. It found that 94% of a globally representative selection of sustainable indices outperformed their parent benchmarks in the first quarter of 2020. The asset manager also notes that its sustainable funds had record inflows during the period.

2. MSCI: Reports that the pandemic is a real-world test of companies with high MSCI ESG ratings and shows they comprehensively outperformed their parent MSCI ACWI index from 1 January to 30 March 2020. MSCI attributes this to a systematic tilt toward higher ESG-rated stocks.

3. AXA IM: Says companies with the highest ESG ratings have been more resilient during the pandemic. It found that these companies have had superior returns for both equities and bonds.

4. Fidelity International: Analysed 2,600 companies to understand the link between their ESG characteristics and their performance from 19 February and 26 March. It found that while the S&P 500 index fell by 26.9%, the companies rated most highly on ESG characteristics fell by 23.1%.

5. Schroders: Reports that ESG indices have outperformed general indices during COVID-19 and that ESG exchange-traded funds (ETFs) have been more resilient to the rush of outflows compared with mainstream ETFs. It notes that “this crisis has actually increased the visibility and perceived importance of sustainable business practices”

6. Morningstar: Reports that most sustainable funds have outperformed their traditional peers over multiple time horizons, including during the COVID-19 pandemic. It found that “in all but one category … sustainable funds outperformed, with average excess returns in Q1 2020 ranging between 0.09% and 1.83% across categories”.

“Many of us in this industry have seen 2020 as the ultimate test for responsible investment. The great question mark was how it would perform during a market turmoil,” says Simon. “What has come through is the fact responsible investors have strongly navigated their way through really challenging markets and generally have outperformed across 2020. This has been really encouraging to see.”

Myth-busting

These outcomes bust the myth that a focus on ethical and sustainable investment means lower returns, Simon told Money & Life. “We see a really large body of evidence from academics and large fund managers that shows responsible investing avoids the worst risks in portfolios.”

Other myths are that responsible investing is expensive and that it is difficult to diversify “We have certified over 200 products across all asset classes, styles and approaches,” says Simon. “The full array of products with many different active or passive styles are available and can be easily searched and compared on our online tool ResponsibleReturns.com.au.”

He says clients are increasingly expecting their financial planners to consider their values and interests. “We see that from our annual consumer research that nine out of 10 Australians think it’s important that financial planners provide responsible and ethical investment options and that 86 per cent expect that financial advisers ask them about their interests and values.

“It’s important that any financial planner starts with a detailed conversation with their client. One of the advantages is the deep client relationships you can build when you talk beyond returns. Understanding all the product options out there will also help a lot in terms of transitioning a portfolio towards ethical and sustainable investments.”

Money & Life, FPA