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Focus on workers, customers and governance drive ESG outperformance amid COVID uncertainty

ImpactAlpha, May 26 – Sustainable funds outperformed their conventional peers in the first quarter downturn and held their own in the April bounce back (see, “Sustainable investments are growing, and outperforming, in a volatile market).

The outperformance was initially attributed to underexposure to the energy sector, which cratered in Q1. As a fuller picture emerges, a bigger driver appears to be a strong focus on workers, customer relationships and governance.

Sustainable investments are growing, and outperforming, in a volatile market

All but two out of 26 ESG indices turned in less negative returns than conventional indexes in the first quarter, according to Morningstar’s Jon Hale, who attributes the outperformance to “the tilt in these portfolios toward companies with better ESG assessments and ratings. Energy underweights were secondary, he says.

“Actually the biggest single factor driving that [outperformance] was securities selection,” agreed Goldman Sachs’ John Goldstein.

The case:

  • ESG characteristics. An analysis by BlackRock, which manages about $100 billion in sustainable assets, suggests energy factors explain only a fraction of sustainable fund outperformance. “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,” BlackRock concluded. The period of COVID-related uncertainty “has further reinforced our conviction that ESG characteristics indicate resilience during market downturns.”
  • Prioritizing workers. Companies like Nvidia, Salesforce and Microsoft that perform in the top quintile on “worker issues” in Just Capital’s rankings of publicly traded companies “significantly outperform” companies in the bottom quintile, on both return on equity and cumulative returns. Just, which has tracked companies’ COVID-related actions, says 38 of the 100 largest U.S. companies have announced at least some financial assistance for frontline workers. A recent Goldman Sachs analysis found that higher employee satisfaction can drive better equity returns over time.
  • Trusted response. Harvard’s George Serafeim and State Street Associates crossed news coverage of corporate responses to the coronavirus with their financial performance to see if favorable sentiment would mitigate investor distrust during the market collapse. They focused on labor practices, supply chains and repurposing of operations, for more than 3,000 companies. The takeaway: More positive sentiment is associated with less negative returns.

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