As the saying goes: You know who your true friends are when times get tough.
This is what happened with ESG funds in March of 2020 when the stock market crashed in reaction to the burgeoning coronavirus pandemic. ESG funds outperformed the market – they were investors’ best friends in the toughest of times – and they continued to thrive throughout the year, including while the market recovered.
Environmental, social, and governance (ESG) – also called conscious, sustainable, or impact – funds outperformed last year on the whole versus their traditional counterparts.
Passive equity ESG funds – those that track an index – did especially well, according to a recent report by Jon Hale, head of sustainability research for the Americas at Morningstar.
“In 2020, three out of four sustainable equity funds beat their Morningstar category average,” he noted in the report. “And 25 of 26 ESG equity index funds (in 2020) beat index funds tracking the most common traditional benchmarks in their categories.”
In his study, Hale looked at 26 sustainable index funds that had close comparisons to traditional index funds. He wanted to primarily answer two questions about ESG funds; how resilient are the funds when the going gets tough, and were investors looking at the funds as ‘nice to haves’, rather than ‘must-haves’ once the environment got tough, or would investors rather fall back on tried-and-true investments in periods of uncertainty?
“What we found was really the opposite of either of those concerns,” he said. “We found that ESG funds as a group performed very well in 2020. … And that ESG funds, when compared to their traditional funds by category, disproportionately finished in the top echelons of their category.”
When looking at individual quarters, the best performance happened in Q1, which is when the market had its correction due to the pandemic. During that first quarter, 24 out of 26 ESG funds outperformed their traditional counterparts.The trend continued throughout 2020 resulting in 18 ESG funds outperforming in Q2, 16 in Q3, and 11 in Q4.
Hale said that this highlights the resilience of firms that incorporate ESG in their operations and management decisions.
“Companies that are well-positioned to take care of their stakeholders – their customers and clients, their workers and that understand their supply chain – some of these areas that have been concerns of ESG investors, may have been better suited to address the Covid crisis than others,” he explained. Also, many funds that focused on the low-carbon economy excluded fossil fuel stocks, which performed poorly last year.
ESG funds also saw the highest inflow yet last year. Hale estimates that for 2020, the total U.S. inflow would top $50 billion. Comparing this to $20 billion in 2019 and $5 billion in 2018 – the growth has been exponential.
“More and more people have a set of sustainability preferences that they use to make decisions,” he explained. “And more and more realize that they can apply their sustainability preferences when they invest.”
ESG’s outperformance wasn’t just for U.S. funds. Funds in developed markets outside of the U.S., as well as those in emerging markets, also did well on a yearly basis. Returns by quarter varied depending on the fund, highlighting the importance of evaluating ESG performance over the long term.
“There’s tremendous momentum for ESG investing that has developed over the last couple of years and that’s going to continue,” said Hale. “In the U.S., the idea that companies need to show greater social responsibility is something that’s growing and we’re starting to shift towards that way of thinking, and away from this idea that companies just exist to serve their shareholders and to maximize their shareholder profit.”