Sustainable investing: resilience amid uncertainty

Sustainable investing: Resilience amid uncertainty

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The tremendous toll of the COVID-19 crisis – on health, economic well-being, and everyday activity – has precipitated a widespread reassessment of the way we live our lives. For governments, businesses, and investors, an essential question has been to understand the sources of resilience during these past few months and how to build on them to prepare for future crises.

Global equity markets signalled the severity of the crisis before much of the world had begun its lockdowns. Equities began their steep descent in late February, and in the course of one month, the Dow Jones Industrial Average fell over 10,000 points (34%)1, demand for cash soared, and economic activity ground to a halt as businesses were forcibly shut down and people directed to stay inside. Amidst this volatile environment, investors have been seeking to understand what characteristics contributed to comparative resilience in portfolios’ performance and how to incorporate these characteristics in their own investments.

The concept of sustainable investing can mean different things. Asset owners and asset managers often operate with multiple definitions, messages and motivations. BlackRock operates from a simple definition of sustainable investing: Combining traditional investing with environmental, social, and governance-related (ESG) insights to improve long-term outcomes for our clients. Our view: Companies with strong profiles on material sustainability issues have potential to outperform those with poor profiles. In particular, we believe companies managed with a focus on sustainability should be better positioned versus their less sustainable peers to weather adverse conditions while still benefitting from positive market environments.

Sustainable investing rises amid market volatility

In this episode of the BlackRock Bottom Line, Brian Deese, Global Head of Sustainable Investing, discusses the strength of sustainable investing so far this year and its outlook for the rest of 2020.

  • As the coronavirus pandemic has unfolded, it has forced us to question many of our basic presumptions as investors. And the same is true for sustainability.

    So what have we seen?

    BlackRock Bottom Line Open

    Title: Sustainable investing: Resilience amid uncertainty

    There’s long been a concern that when it comes to sustainable investing, when we hit a market downturn and we hit a disruption, that would cause investors to run away from sustainable.

    What we’ve seen in this crisis, it’s obviously a short time period but is striking, is the opposite. That notwithstanding, a dramatic and historic market drawdown, we’ve seen record inflows into sustainable strategies during this same period.

    And that reinforces the view that the structural shift in investor preferences is more durable than short-term market movements. 

    We have seen a striking degree of resilience associated with companies and portfolios that have greater sustainability characteristics. More than 90% of sustainable indices outperformed their parent benchmark during the period of the heightened market uncertainty and drawdown associated with this crisis. 

    (Source: BlackRock, with Q1 data from Bloomberg and Morningstar as of May 7, 2020)

    Companies that are focused on their employees and their customer base and the communities that they operate in are able to operate more nimbly in an environment where what was assumed in the past can no longer be assumed. It makes them more agile and more able to weather uncertainty.  

    As we look forward, just as how companies have treated their employees and their stakeholders in the current crisis has been a differentiator, we believe how companies invest in their employees’ health and safety will be even more important. 

    Second, there’s going to be an increased expectation on companies around traditional governance issues, but also questions of a company’s purpose and its contribution to the communities that it operates in.

    Across all these areas we believe that sustainability issues will become even more salient in the investment conversation going forward. 

    The bottom line is that sustainability has been tested during this crisis and as we look forward, we believe that sustainability will be even more important to how we invest and how companies succeed over the long term.  

The recent downturn was a key test of this conviction. In the first quarter of 2020, Morningstar reported 51 out of 57 of their sustainable indices outperformed their broad market counterparts, and MSCI reported 15 of 17 of their sustainable indices outperformed broad market counterparts - robust across region and index methodology.2,3 While this short time period is not determinative, it aligns with the resilience we have seen in sustainable strategies during prior downturns in 2015-2016 and 2018, which are explored in our research. Furthermore, these results are consistent with the research BlackRock has been publishing since mid-2018, demonstrating that sustainable strategies do not require a return tradeoff and have important resilient properties.4

For investors, the most important question is why? What explains the resilience?

Research by BlackRock5 has established a correlation between sustainability and traditional factors such as quality and low volatility, which themselves indicate resilience. As a result, we would expect sustainable companies to be more resilient during downturns.

Traditional factors, however, do not describe the full set of attributes that can impact a company’s resilience. Analysing the various sustainability characteristics of companies – and how these characteristics contributed to performance – deepens our understanding of how sustainability reinforces resilience.  Our research indicates that, in the current crisis, with its transformative and devastating impact on daily life, companies with a record of good customer relations or robust corporate culture are demonstrating resilient financial performance.

Casual observers initially attributed the strong performance of ESG funds to their relative underweighting to traditional energy companies, whose prices fell further than the overall market during the downturn. However, our own analysis and third-party research6 shows that the underperformance of traditional energy explains only a fraction of the outperformance seen in many sustainable funds.

We believe that the outperformance has instead been driven by a range of material sustainability characteristics, including job satisfaction of employees, the strength of customer relations, or the effectiveness of the company’s board. Overall, this period of market turbulence and economic uncertainty has further reinforced our conviction that ESG characteristics indicate resilience during market downturns.

Another key piece of the resilience story has been investor preference for sustainable assets during the crisis. As investors have sought to rebalance their portfolios during market turmoil, they are increasingly preferring sustainable funds over more traditional ones. In the first quarter of 2020, global sustainable open-ended funds (mutual funds and ETFs) brought in US 40.5bn in new assets, a 41% increase year-over-year. U.S. sustainable funds attracted a record US 7.3 billion for the quarter.7

We believe these inflows during a period of extraordinary market drawdown suggests a persistence in investor preferences toward sustainability. They upend an oft-cited concern pre-COVID crisis that during sharp market downturns, investors will de-prioritise sustainability. And they offer important, though short-term, evidence that the incipient shift in preferences – which was explored in research by the BlackRock Investment Institute earlier this year 8 – has been accelerated by the crisis and is another key contributor to the resilience of sustainable funds. 

In our research, we analyse performance differences between ESG indices and their core, non-ESG, versions, as well as ESG-managed funds versus their peers, and we find that the majority of ESG-tilted portfolios have outperformed their non-sustainable counterparts during this year’s market downturn. We also examine a variety of sustainability-related themes using our research-driven framework for assessing and integrating material sustainability insights to understand the performance of each theme during the downturn. We find particularly strong performance in themes including customer relations, firm culture, and board effectiveness, providing insight into resilience during this crisis. Finally, we explore the increasing allocation to sustainable portfolios during the crisis and the structural shift in investor preferences to sustainable assets.

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1Source: Bloomberg. Period: February 20, 2020 to March 20, 2020

2 https://www.morningstar.com/insights/2020/04/06/how-did-esg-indexes-fare

3 https://www.msci.com/www/blog-posts/msci-esg-indexes-during-the/01781235361

4 BlackRock Investment Institute,“Sustainable investing: ‘a why not’ moment” May 2018; Sustainability: the bond that endures, November 2019

5 Ibid.

6 https://www.morningstar.com/articles/976361/sustainable-funds-weather-the-first-quarter-better-than-conventional-funds

7 The data for this analysis is captured from a number of sources by BlackRock, including provider websites, fund prospectuses, provider press releases, provider surveys, Bloomberg, the National Stock Exchange, Strategic Insight Simfund, and Wind. All amounts are reported in US dollars. Flows are derived using daily net asset values and shares outstanding using the most recent data we can capture at month-end. For products with cross-listings, we attribute net flows and assets to the primary listings. Data is as of March 31, 2020.

8 BlackRock Investment Institute, ‘Sustainability: The tectonic shift transforming investing,” February 2020

Where we stand

Sustainability is fundamentally reshaping finance
Sustainability is fundamentally reshaping finance
Climate change is driving a profound reassessment of risk and we anticipate a significant reallocation of capital.
Putting sustainability at the center of how we invest
Putting sustainability at the center of how we invest
Sustainability-integrated portfolios can help investors achieve their financial goals.