Sustainable investing: Resilience amid uncertainty

BlackRock |18-May-2020

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.

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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.

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 USD 40.5bn in new assets, a 41% increase year-over-year. U.S. sustainable funds attracted a record USD 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 year8 – 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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