Investing involves much more than just picking a few stocks to put in your portfolio. Investment is a diverse and evolving landscape that has undergone numerous large-scale shifts over the years. One of these is the shift towards ESG Investment. This approach to investing is based on a decision-making process that considers Environment, Social and Governance factors as part of the risk assessment process.
The COVID-19 crisis has caused a major shift in attitudes towards ESG investing. ESG investments proved much more resilient to the volatility that has gripped markets since the onset of the crisis. This has attracted even more attention to the space, especially on the part of institutional investors.
“The recent crisis has shown that ESG investments have beaten their benchmarks in terms of mitigating losses and faster recovery, which basically proves the thesis – you can make money better if you include ESG factors,” said Roman Gaus, an ESG analyst and an investment advisor to Farmfolio. Based in Switzerland, Mr. Gaus has kept a close eye on the ESG space for over a decade.
“Investors with ESG-integrated portfolios have been much more insulated against the COVID crisis.This is in part because the ESG risk analysis process involves screening companies who don’t meet certain norms and standards, such as tobacco or coal. You try to narrow down your investment target so you get a better return, or lower risk, and obviously there’s an element of impact beyond what you want to achieve as far as financial performance and risk mitigation strategy.”
“One factor that has attracted a lot of awareness to ESG is the oil price crash. Investors who were too exposed to fossil fuels and oil-dependant industries like airlines and cruise lines have suffered heavy losses during the crisis. ESG-integrated portfolios were already sort of inoculated against that risk,” said Mr. Gaus.
Over the last two decades, ESG investment principles have gained mainstream acceptance. A recent report from Morningstar shows that estimated net flows into sustainable exchange-traded funds available to U.S. investors rose $20.6 billion in 2019. This is about four times the amount compared recorded in the previous year.
“ESG is growing not only in terms of Assets Under Management but in terms of types of product offerings. For example, there are many, many more ESG-integrated ETFs now than there were a decade ago – Blackrock alone has almost 100. Whether investors believe in sustainability or not, they still want exposure to megatrends like the shift towards renewable energy, water access, agriculture, healthcare for an aging population, etc.”
“The COVID situation is going to play a big role in this. If you look at how people want to reposition their portfolios, they’re going to take a closer look at stock market risk and try to divest from some of those risks, including dependency on and exposure to fossil fuels.”
The data certainly seems to corroborate this. A recent report from Chain Reaction Research indicates that “the early positive indicators of the ability of ESG funds to handle stress testing in a bear market may go a long way to improve investor confidence in a relatively new field,” noting that even in a troubled Q1 2020, sustainable funds have seen “record breaking inflows.” The report also notes that ESG-integrated funds were less exposed to now-troubled industries, and may also have managed to avoid many of the reputational risks that “arise from poor governance and stakeholder management.”
Indeed, in the first quarter of 2020, sustainable index funds outperformed conventional index funds 92% of the time, according to a Morningstar study based on 26 index funds covering U.S. stocks, non-U.S. developed-markets stocks, and emerging-markets stocks. In terms of equity funds, 44% of sustainable equity funds ranked in their respective category’s top quartile, the report states.
More and more investors are looking to ESG not just to improve the impact of their investments, but as an effective strategy for increasing returns and mitigating risk. The Schroders 2019 Global Investor Survey reveals that over half of all investors under the age of 71 believe that all investment funds should incorporate ESG factors, indicating the intergenerational appeal of the practice.
“One of the biggest changes you’re going to see in response to this crisis is the incorporation of ESG criteria by private investors. Until now, ESG integration was more common among institutional investors, but now, as private investors are coming to terms with the reality of the COVID crisis, more and more are going to integrate ESG methodology into their portfolio decisions,” said Mr. Gaus.
“The flight into alternative assets sparked by COVID will hopefully result in a big boost for the ESG space. People are going to realize that ESG analysis is not really negotiable, and even those who aren’t so concerned about impact will realize that ESG is a great way to assess risk and maximize returns.”
It certainly seems that the COVID situation will result in a more ESG-conscious investment landscape. By strongly considering non-financial risks when repositioning their portfolios, investors can not only mitigate risk and increase returns – they can make a positive ESG impact as well.