TheWealthNet: Why responsible investing has outperformed throughout the pandemic
By Robert Weeber | July 2, 2020
The novel coronavirus has upended normal life and rattled markets around the world. Without a vaccine, cure, or even clear reopening of the global economy in sight, investors are pricing in prolonged uncertainty and negative growth as consumers face restrictions on travel, dining and spending in general. One silver lining for investors, though, would be the relative outperformance of responsible investment strategies during the recent downturn.
According to a Morningstar report, over two-thirds of sustainable equity funds finished in the top half of their categories through Q1, with an additional 44% generating returns within the top quartile. Remarkably, only 11% of sustainable equity funds placed in the bottom 25%.
Our own balanced impact portfolio returned -7.9% for the first quarter. In comparison, the 50% MSCI ACWI/50% Muni 1-10 year, its traditional blended benchmark, returned -11.34%, demonstrating the overall outperformance of the impact category compared to equities at large.
Responsible investing strategies are consistently delivering better performance during the pandemic, and it is in large part the result of thematic advantages, as well as idiosyncratic tailwinds from strong governance dynamics.
The first and most obvious reason that responsible investing strategies have outperformed peers is that portfolios scoring high on ESG have been structurally underweight to carbon intensive industries and traditional energy, which has been doubly-hit because of the OPEC-Russia oil dispute. This has helped limit exposure to the worst performers of the past two months; and responsible investing’s focus on quality has prioritised companies with durable balance sheets and sectors such as biotech, healthcare, and information technology. These sectors will be in high demand by an ever-widening audience over the next few years, seeding the ground for strong comparative returns.
In the private markets, thematic opportunities in venture capital-backed companies specialising in educational tools and connectivity software – two areas with exploding customer universes – have proven additive. The prioritisation of our environmental and equity lens strategies not only aligned with shareholder values, they’re poised to succeed coming out of this crisis.
Real estate is another sector where impact strategies benefit from inherent downside protection. Impact portfolios typically have exposure to real estate through housing developments that participate in rental assistance programmes, such as section 8 housing in the U.S., that, critically, offer a backstop for a portion of a given portfolio (often greater than 50%, though sometimes less). So, rent cash flows don’t dry up even when renters are unable to pay – a strong assurance in a recession.
Cash, an often-overlooked allocation, has also been put to use in interesting and timely ways. Instead of holding cash at large financial institutions that don’t necessarily deploy assets according to a socially responsible lending criteria, impact investors have turned to community lending. Leveraging cash distribution tools, they invest in small banks and credit unions which then use the funds to issue loans and support community programmes, boosting job growth, infrastructure development, and social services. Such strategies yield similar returns and liquidity as standard money market accounts.
What’s more, The CARES Act, for example, enacted by the United States government has outlined guaranteed SBA and economic disaster loans which will be most effectively facilitated via local lending partners. Top performing responsible strategies are already helping to fund these loans through cash allocations, battling back against the coronavirus downturn while preserving capital.
In the long term however, I believe that the story of this crisis and who weathered the storm might come down to governance. The companies that will outperform right now are those that have been well managed and have strong balance sheets with low debt loads. Good governance means flexible leaders who encourage working from home, and communicate openly about employee safety and organisational direction.
Companies that choose to support the coronavirus relief will also see a lasting reputational effect. Louis Vuitton repurposed their perfume plant to manufacture disinfectants, Nike is pumping out face shields and New Balance is sending masks to the front lines. These key decisions to spend money on the greater good will expedite the economy’s recovery and earn the trust of consumers.
The impact of good governance will not play out in a single quarter. It will unfold over the course of 2020 and into 2021, and ESG-aligned managers with a strong focus on governance and quality are poised to capitalise on this trend.
Though the entire market suffers from hampered consumer spending, the future-proofing mindset of responsible investing has proven a good salve for losses. Thematic choices to move away from carbon and lean into socially beneficial assets have been especially fruitful in a world where movement is limited and relying on others has become necessary.
Hopefully the global response to COVID-19 is not only effective, but may also serve as a blueprint for how countries collaborate on other pressing global challenges, such as climate change and income inequality.
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