The recent growth in sustainable investing has coincided with a bull market that began at the end of the Great Financial Crisis in 2009. Therefore, most funds integrating Environmental, Social, and Governance (ESG) factors in the investment process had not yet been tested during a severe market downturn — until the S&P 500 fell 34% in just 23 trading days between February 19th and March 23rd. So, how did these ESG-integrated funds perform during the downturn?
Overall, most sustainable equity funds, like most conventional equity funds, lost money during the first quarter of 2020. However, research from Morningstar shows 70% of sustainable equity funds in the Morningstar database ranked among the top 50% in their respective peer groups, and 44% ranked in the top quartile. Overall, sustainable funds were 4 times more likely to rank in the top quartile than the bottom one. Among index funds, 10 out of 12 sustainable US large cap index funds outperformed the S&P 500 by an average of 0.50% (50 basis points), and 11 out of 11 sustainable international index funds outperformed the MSCI EAFE index by an average of 1.9% (190 bps).
These results can be partially explained by the fact that sustainable funds tend to underweight the energy sector due to climate concerns. Energy companies faced a “perfect storm” in Q1: oil demand virtually evaporated when large parts of the global economy locked down to combat the novel coronavirus, just as Russia and Saudi Arabia started an oil war that caused a supply glut — all of which resulted in particularly poor performance for the sector. Sustainable funds also tended to benefit from overweights to the healthcare and technology sectors, which have been imperative in combating the virus and enabling white collar workers to transition to a work-from-home environment, respectively.
However, Morningstar found these sector allocations only accounted for part of the relative outperformance among sustainable index funds. The largest positive contributor was the overweight of companies with strong ESG credentials and underweight or exclusion of those with poor ESG scores. These findings are confirmed by JUST Capital, a non-profit that ranks companies on how they serve all their stakeholders — workers, customers, communities, the environment, and shareholders. JUST has been tracking how America’s 100 largest employers have responded to the corona crisis across various dimensions. They found that companies who have taken sufficient steps to protect their workers, such as offering additional paid sick leave and providing free personal protective equipment, have significantly outperformed their peers financially during the first quarter. So have companies that have gone out of their way to accommodate customers by offering special business hours to vulnerable populations, as well as discounts or deferred payments for goods and services.
All of this adds to the growing body of evidence that investors don’t need to sacrifice returns to favor companies who effectively manage their social and environmental impacts — and investors are taking note. Despite the market downturn, Morningstar reported sustainable equity funds set a new record of $10.5 billion for net total inflows during the quarter. About half of these flows came in January when investors were still enjoying a record bull market, but both February and March saw net positive flows, too. Although a significant market downturn can be stressful to even the most patient investors, it’s encouraging to see sustainable equity funds continue to hold up — both in terms of relative performance and investor demand.