ESG outperformed strikingly during the recent market meltdown of equity and bonds issued by companies with high scores within those asset classes. This is the clearest example yet of the ability of the sector to deliver superior financial performance and an indication of a shift in the institutional asset management community zeitgeist.
According to newly published research from Fidelity International, on the way down in the fastest bear market in US capital markets history – a decline of 27% hit over a period of 36 days, between February 19 and March 23, in the S&P 500 – equity and fixed income securities issued by companies at the top of Fidelity’s sustainability rating scale dropped less than the index while those at the bottom exceeded its decline.
The equity of companies rated A or B on the ESG in the company’s proprietary sustainability scoring model performed on average 3.8% better than the S&P during the market rout, while those rated C to E performed 7.4% worse.
“No asset was spared as the severity of the economic shutdown needed to contain the coronavirus outbreak became apparent to investors. The quickest US bear market in history, from February to March this year, was also the first broad-based market crash of the sustainable investing era,” says Jenn-Hui Tan, global head of stewardship and sustainable investing at Fidelity International.
“Our thesis, when starting the research, was that the companies with good sustainability characteristics have better management teams and so should outperform the market, even in a crisis. The data that came back supported this view.”
Meanwhile the same ESG-outperformance phenomenon was witnessed in the fixed income secondary markets, where from the start of the year to March 23, bonds issued by companies with high ESG scores outperformed their lower rated peers returning -9.23% on average for those rated A, versus a -13.2% return for bonds issued by B-rated companies and -17.14% for those rated C.
“While some caveats remain, including adjustments for beta, credit quality and the sudden market recovery, we are encouraged by evidence of an overall relationship between strong sustainability factors and returns, lending further credence to the importance of analyzing ESG factors as part of a fundamental research approach,” says Fidelity’s Tan.
Fidelity’s scores were based on a performance comparison across more than 2,600 companies, and its forward-looking ESG ratings are derived from direct engagement with companies, comprising around 15,000 discrete company meetings per year.
“The recent period of market volatility was shocking in its severity. A natural behavioural reaction to market crises is to lower investing horizons and focus on short-term questions of corporate survival, pushing longer term concerns about environmental sustainability, stakeholder welfare and corporate governance to the background.”
“But this short-termism would indeed be short-sighted. Our research suggests that, what initially looked like an indiscriminate selloff did in fact discriminate between companies based on their attention to ESG matters.”
Fidelity’s research comes at a time for mixed signals within ESG. Whereas the EU has taken a step back from implementing its ambitious zero emissions policy, the “S” element of ESG is taking centre stage as governments and corporations rush to address the social fallout from Covid-19 and its impact on employment and mental health.