There are two foundational themes to the discussion of the merits of ESG (ethical) investing: values and performance. The COVID 19 experience can be expected to impact both of these. For many ESG investors, the impact on performance is likely to be the most interesting, and perhaps the most difficult to predict.
Historically, ESG-motivated investing has been stigmatised by some as adding a hindrance to the pursuit of superior risk-adjusted investment portfolios and the optimization of returns. In short, their argument is that, perhaps by limiting the universe of investment choices (through the exclusion of companies, sectors, or entire industries) ESG-investors will sacrifice performance as they express their values.
Over the past few decades, however, this negative perspective has been increasingly challenged by an important feature of the evolving ESG landscape: the emergence of large, international, information- gathering entities such as Bloomberg, MSCI, Sustainalytics and others, which are providing increasing amounts of historical data for investment analysis.
It seems that, increasingly, analyses of ESG-inspired portfolios by academics, NGOs, for-profit enterprises, and enthusiastic amateurs are reporting improving, and even slightly better performance when compared to well-recognized investment benchmarks. Some of this improvement may be due to the potential of an ESG portfolio to reduce exposure to companies with poor governance compared to their peers. Poor governance may be more likely to lead to bad (even, unethical) business choices, and the (perhaps inevitable) fall-out that follows the discovery of said choices. So it is argued ESG investing may reduce some specific downside risk.
Additionally, these reports are suggesting that companies that score well based on ESG metrics relative to their peers may outperform those peers. This outperformance may come from consumers preferring to select the products and services of those companies, resulting in increased market share and profitability. The effect may also be due to increasing investor support as an expression of values, or because of the potential for that increased market share and profitability to result in superior investment performance. So it is argued that ESG investing may have more upside.
How will the COVID 19 experience impact these analytics and performance?
The rising tide of bull market performance over the past decade has raised all boats – many ESG investments included. With the pandemic, the tide has gone out: all boats will drop, some may sink, and the proverbial naked swimmers will be seen.
As uncomfortable as this disruption is, it can provide an extremely important opportunity for ESG analysts: a wealth of new data to be mined. Miners will be able to test their hypotheses, and reconsider the relative merits of ESG portfolios, in a much more varied and volatile market environment that we have seen in a while (or ever), and perhaps answer some important questions:
- Did ESG portfolios better retain their value during that disruption?
- Were ESG portfolios subject to less volatility during that disruption?
- Did ESG portfolios recover faster when markets turned?
- Were companies with strong ESG metrics more likely to survive?
This disruption and data may also provide some insight as to whether or not specific product types or professional resources resulted in a more satisfying investor experience:
- Did ESG-branded mutual funds, for example, perform differently from ESG ETFs?
- Did discretionary portfolio managers, with the ability to actively manage portfolios, fare better than those with less flexibility?
- Did investors feel they received sufficient value for fees paid?
- Will investors conclude that some ESG-related products and services are not worth the price?
Such data and performance will ultimately be historical, and, therefore, not a guarantee of any particular future performance. However, the past is what we have. During future reflections, I expect that a welcomed legacy of this COVID 19 experience will be an increasingly clarified picture of ESG investing performance and potential. I am looking forward to seeing that picture.
Posted with permission. Original content by:
Rod Burylo
Associate Portfolio Manager
Manager of ESG Integration
Calgary, Alberta
rburylo@croftgroup.com
Rod Burylo, CIM, FCSI is Manager of ESG Integration and Associate Portfolio Manager for Croft Financial Group. Rod is an Advisor of the Year Award winner, 2019 IFSE Institute Award for Financial Literacy Champion finalist, international speaker, and business author, including his most recent book: The Wealthy Buddhist…Buddhist Ethics, Right Livelihood, and the Value of Money.
None of the information provided by Rod Burylo should be understood as a recommendation for any particular investment, product, strategy, or service. Readers should consult a professional for guidance regarding their personal circumstances.