Market Volatility, ESG, and Deeper Client Engagement

Kiley Miller Associate Portfolio Manager – Impact Portfolios

The coronavirus pandemic has sent shock waves through the global healthcare system, our communities, and our economy. By investing in strategies that integrate environmental, social, and governance (ESG) criteria into analysis, advisors can offer their clients downside protection, more resilient portfolios, and a way to connect with the issues they care about most.

Outperforming During Market Drawdowns

As Bank of America put it, “ESG is a bear-market necessity, not a bull-market luxury.” 1 Because ESG analysis serves as a lens to better evaluate risk, managers who do it well can provide investors downside protection. In 2019, Bank of America published a report indicating that ESG is an effective signal of future quality, or earnings stability.2 It also found that an investor holding stocks with above average overall environmental and social scores would have avoided more than 90 percent of the S&P 500 bankruptcies that have occurred since 2005. BlackRock also found that sustainable portfolios tend to have a quality bias, providing greater downside protection in “risk-off” periods.3

In the context of an 11-year bull market, this thesis remains to be proven. However, over the last few weeks of unprecedented market volatility, findings from Morningstar, MSCI, and S&P indicate that ESG strategies are weathering the storm better than traditional ones.

Morningstar found that in the first quarter of 2020, seven out of 10 sustainable equity funds finished in the top 50 percent of their Morningstar categories, and 24 of 26 ESG-tilted index funds outperformed their nearest conventional counterparts.4 Morningstar notes that a lower exposure to energy and a higher exposure to technology in these funds contributed to outperformance. It states that the primary driver was that “sustainable funds appear to have benefited from selecting stocks with better ESG credentials.”

Morningstar also tracked performance of ESG and non-ESG ETFs, comparing rolling monthly returns up to March 20th in four Morningstar categories.5 The results show that ESG ETFs outperformed non-ESG ETFs in three of the four categories examined: Global, Europe, and U.S. Large-Cap.

Analysis from MSCI found positive results for its U.S. ESG indexes; the MSCI ACWI ESG Leaders Index outperformed the MSCI ACWI by 1.1 percent from January 31st to March 12th.6 S&P findings also show that ESG indices did better than non-ESG counterparts.7 These findings strengthen the case for ESG integration by demonstrating the value of this additional risk lens in the investment process.

ESG analysis also provides information to more comprehensively evaluate customer loyalty, reputation, and brand value, dimensions that increasingly drive valuations. Companies that better manage human capital, community relations, and supplier relationships, for example, will be better positioned for market downturns. The global pandemic is evidence that social and environmental challenges and investment drivers are increasingly overlapping. By applying ESG criteria, advisors can help reassure clients of the resiliency of their portfolio and reinforce that they can be long-term stewards of capital.

Addressing The Needs of Stakeholders

Advisors can share ESG insights to inform clients about how companies are responding to the current COVID-19 crisis. Consumers are paying close attention to how companies are treating key stakeholders, beyond investors. They’re concerned about how companies are supporting their employees, providing paid sick leave, and offering flexible work arrangements. They want to know how companies are supporting their communities in need and whether they’re honoring their contracts and commitments with key suppliers. These concerns mirror those that fund managers who integrate ESG insights express directly to management teams.

With these insights, investors are better informed about how companies are managing their key stakeholder relationships. Companies that do this well and are prepared will be more likely to endure a recession and bounce back.

In addition to providing companies with opportunities to demonstrate resilience, the coronavirus is giving them the chance to demonstrate tenacity in addressing societal issues. Many of the companies showing resilience and innovation right now are those with strong ESG profiles, like Microsoft.

In response to news about the coronavirus, Microsoft was one of the first major employers in the U.S. to mandate that employees work from home.8 Its also continuing to pay its 4,500 hourly service providers, even though the company’s need for their services has fallen.9 Additionally, the CDC is using Microsoft’s Healthcare Bot services in the release of a COVID-19 assessment bot that will help screen patients for potential infection and care.10 These efforts indicate a preparedness to act and innovate to serve employees and communities.

Gaining Insights by Tracking Company Behaviors

Several companies are creating systems to track company behaviors. These systems generate data that can help ESG-focused investors better understand how companies engage with their stakeholders.

Truvalue Labs has built a monitoring tool that tracks how company actions during the coronavirus outbreak are being reported through the news, social media, and financial press.11 This data provides insight into public sentiment, reputation, and key issues for stakeholders. The tool identifies employee health and safety and labor standards as the top issues in ESG-related company news.

Just Capital has also released a tool that is tracking corporate responses to the pandemic.12 The company identifies Target as a leader in the areas of worker health and financial security.13 The company established a COVID-19-specific paid sick leave policy, raised wages for frontline workers, and offered paid leave for up to 30 days to workers who are pregnant, 65 years old or older, or who have underlying health risks. It has also provided workers with access to 25 days of free back-up care per dependent.

Microsoft and Target are examples of companies that are staples of ESG-focused portfolios.

Building Portfolios That Address Societal Concerns

In a time of global economic uncertainty, investors are looking for guidance and support. Using an ESG approach to investing, advisors can build additional resilience into portfolios, encourage a long-term investment thesis, and provide a way to show clients how the companies they’re invested in are addressing our most pressing social concerns.

Envestnet | PMC offers carefully vetted and constructed impact strategies that can be tailored to each client’s interests, convictions, and circumstances. Learn more about how Envestnet can help you Invest with Impact, adding a new dimension to your practice with solutions that support both positive social impact and financial goals.

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