Many seem to harbour the notion that ESG investing – an acronym for Environment, Social, Governance - is a detractor to performance. To do your bit for the planet or follow ethical practices in corporate governance, you have to sacrifice returns. But evidence is debunking the myth that there is a performance penalty associated with ESG investing.
Europe
Morningstar examined the long-term performance of nearly 4,900 funds domiciled in Europe, including 745 sustainable open-end and exchange-traded funds (ETFs).
The study compared average returns among the sustainable and traditional fund cohorts over the past 1, 3, 5 and 10 years through December 2019, as well as during the coronavirus crisis (first quarter of 2020). Sustainable funds were evaluated against a composite of traditional funds in each category.
While you can access the study here, below are the key takeaways:
- Average returns and success rates for sustainable funds across seven Morningstar Categories show no performance trade-off associated with sustainable funds.
- A majority of sustainable funds outperformed their traditional peers over multiple time horizons.
- Over the 10 years through 2019, nearly 59% of surviving sustainable funds across the categories have beaten their average surviving traditional counterpart.
- Sustainable funds held up better than their traditional counterparts during the COVID-19 sell-off, delivering superior returns in all but one category.
- Fees are a crucial consideration when selecting a sustainable fund. Lower-cost options tend to have greater odds of success.
The U.S.
During the late-2018 stock market decline, ESG funds proved more resilient than most funds. Then came the pandemic and some of the most volatile conditions in stock market history. During the market turmoil, returns on many ESG funds proved to be more buoyant than those on comparable non-ESG funds.
While some of that outperformance is attributable to ESG funds’ significant underweighting of energy stocks--a group pummelled by the plunge in oil prices--the first quarter was just the most recent, and extreme, example of ESG funds performing better during down markets than their non-ESG peers.
A recent study started with a list of 230 diversified stock and allocation funds with an ESG mandate. The hurdle was that the overall number of ESG funds is still relatively small. Some categories have only six offerings, and many have less. Many strategies are new, and many have a tiny level of assets. Nearly 100 of the funds didn’t even crack the $100 million mark, so it was decided to draw the line at $50 million. The final result was a list of 137 funds across 19 categories.
The study used the Down Capture to study whether a fund fell more or less than the broad market or category of funds when stock prices decline. That means, for example, comparing large-blend ESG funds and large-blend funds overall against the Russell 1000 Index.
The study also employed Standard Deviation, a volatility yardstick that measures how far a fund’s returns deviate from average over different time periods.
While you can access more details of the study here, below was the key finding.
At a broad level, the story was consistent: Over the past 1, 3 and 5 years, ESG stock and allocation fund strategies lost less money than non-ESG funds during market declines and displayed less volatility. Among 11 Morningstar Categories, the average down capture for ESG funds through the year ended March 31 was nearly 12% better than category averages.
India
SBI Mutual Fund conducted a study as part of an overall analysis to decipher their level of preparedness to address various kinds of risks as a company, sector and geographic level.
Using the framework of a global ESG ratings provider, the study analysed the price movement of the companies under the AMC’s coverage.
The fund house also wanted to look at whether certain sectors that are considered more ESG oriented, or perform better on ESG metrices, display superior performance. Employing the ESG ratings of another global provider, to see if the trend is coherent across the service providers, they looked at sectors. They calculated the average ESG scores for all companies under various industrial sectors and mapped them to the average stock price change for the relevant industrial sectors.
In India, the first Covid-19 case was reported in the media on January 30, 2020. Keeping that in mind, the price of the stocks on January 1, 2020 was taken as the base.
Pharmaceutical and healthcare stocks, and the sector as a whole, were excluded from the above studies. This sector got a fair amount of positive traction due to the nature of the crisis, and would skew the assessment of other sectors.
Some of the sectors included in the top 10 ESG scoring sectors:
- Specialty chemicals
- Household products
- Household appliances
- Personal products
- Wireless telecommunication services
Some of the sectors included in the bottom 10 ESG scoring sectors:
- Coal and consumable fuels
- Diversified metals and mining
- Steel
- Aluminium
- Oil and gas production
The time frame is too short. There could be multiple factors involved. Nevertheless, that does not take away from the fact that the results are very telling and worth monitoring.
Increasingly, it is becoming evident that the companies that manage their ESG risks well perform better. It is a win-win situation, from the point of view of outperformance and ethical practices.