ESG stocks Thriving during COVID-19 Crisis
“Do good and good will come to you” has been a true phenomenon recently in Equity markets globally. This trend has confirmed its status during the recent COVID-19 sell-off (28/02/2020 - 01/04/2020). ESG companies in Europe & the US have outperformed both the “sin” stocks (Tobacco, Alcohol and Gambling) and the broad markets. Strong ESG companies, as defined by proprietory Velox methodology, have also outperformed their weak ESG counterparts. Whilst ESG companies have outperformed on return, it is also worth noting that the outperformance is even more significant on a risk adjusted basis. There has been an ongoing trend of ESG securities reducing portfolio volatility for a few years now and this was again confirmed during the biggest sell-off seen in a decade.
A best-in-class European index, that tracks companies with strong Environmental, Social and Governance credentials, has outperformed its broad market counterpart by 2.61% since the start of the year and 1.92% since the February sell-off, as published on Bloomberg. This lends credibility to the argument put forth by ESG proponents that companies doing good on E, S or G are more liked by investors in the current day and age.
At first, one might think that the outperformance would be due to the Oil price crash and absence of Oil majors in the ESG index. However, once we look under the hood, we can see that the ESG index is constructed by selecting the top scored ESG stocks from various industries. Energy and Utilities are also part of the index and together total up to 10% weight. Total, Neste Oyj and Iberdrola, for example, are part of the index. The Oil price crash was a systemic risk that affected both the ESG and the broad market index and the outperformance of the ESG index is due to other factors.
Good governance credentials have been a big factor that has helped ESG outperform broad market. A JP Morgan research paper concluded that during the crisis the top quartile of companies ranked by governance scores have outperformed the bottom 3 quartiles significantly. This can primarily be attributed to increased investor understanding of these metrics and their belief that good governance is a key ingredient to navigating the crisis. Source(Subscription to JPM research Required) A similar trend is seen with companies that are best in their industry in social factors, such as employee flexibility, training or product safety and quality.
Healthcare, for obvious reasons, and Telecommunications for increased connectivity needs during the largest “work from home” exercise, were touted as two beneficiaries of the crisis. If you look at the Stoxx 600 performance by sector during the sell-off, it will be apparent that these two were amongst the best performing sectors. Healthcare only went down by 3.13% and Telecommunications by 14.68% compared to the 16.92% sell-off of the broad market. After further analysis, one can see that even within these sectors, companies with good ESG credentials did much better than the whole sector. The Healthcare portion of the ESG leaders index returned -0.59% vs -3.13% for the Stoxx. The Telecommunications portion of the ESG leaders index returned -10.53% vs -14.68% in the Stoxx. Also, companies in Healthcare that had a positive return during this sell-off are all rated AAA or AA on ESG by MSCI. And all these companies, except one, are in the top quartile of the sector in governance credentials. This is also true for underperforming sectors. During the recent sell-off, Automobiles in Europe has been one of the worst hit sectors due to decreased expected demand. The Stoxx Automobiles sector went down by 28.66%. The Automobiles portion of ESG Index, however, went down only by 23.02%.
Velox investment universe have had a similar picture. Companies flagged as “Green” using the Velox fund methodology have on average outperformed their “Red” counterparts by 8.01% since the sell-off. An equally weighted portfolio of Red Securities performed -24.4% vs -16.39% for the Greens. In 15 out of 20 industries, the Greens outperformed the Reds during this sell-off. Whilst in the above example we saw a 2.54% outperformance of ESG leaders Healthcare vs broad market Healthcare, using Velox flagging methodology, the Velox Healthcare Greens outperformed the Velox Healthcare Reds by 19.85%.
One cannot speak about return without speaking about risk. After all, The Velox philosophy is centred on maximizing risk-adjusted returns. Good ESG companies have turned out to be a lot less volatile during the sell-off (28/02/2020 - 01/04/2020) giving a much better risk return profile to the ESG leaders index compared to the broad market.
The Velox Greens have also been a lot less volatile compared to the Reds. The portfolio of Greens has had a daily volatility of 3.82% vs 4.90% for the Reds during this period.
Now that we have had a rebound in the equity markets, one can also happily conclude that good ESG companies are outperforming the broad market. The above European ESG leaders index has shown a 1.00% outperformance since the March lows (16/03/2020 till 15/05/2020).