The scale of the pandemic and the response elicited has shone the light firmly on the ‘S’ of Environmental, Social & Governance (ESG) factors, but all three issues have come to the fore as the crisis has developed. Eoin Murray, Head of Investment, at the international business of Federated Hermes, takes a closer look at ESG performance and the importance of addressing these factors over the long-term.
Coronavirus has disrupted economies and financial markets in unprecedented ways, exposing the global economy’s lack of preparedness and resilience and radically reconfigured perceptions of sustainability.
Social factors once deemed to be non-financial or extra-financial concerns, have very clearly demonstrated that they are in fact financial matters indeed. We contend that their importance will only grow stronger through the global recovery and into the post-crisis world. The experience of what worked and what didn’t through the recent period must provide a framework for sustainable investment approaches going forwards.
Our proprietary research demonstrates that investment strategies which integrate ESG factors have historically outperformed those that do not. This observation, supported by academic evidence, holds across all asset classes. While we remain focused on sustainable value creation over long-term time horizons, YTD comparisons evidence the relative resilience of ‘social outperformers’ across equities, and of ESG factors more broadly in credit, through the recent market turmoil.
Research from our Global Equities team reveals that companies with poor or worsening social practices consistently underperformed their peers by 15bps each month since the beginning of 2009.
A study from Beyond Ratings and our Credit and Responsibily teams indicates that countries with the highest ESG scores (quintile five) have the lowest average CDS spreads, while those with the lowest ESG scores (quintile one) have the highest average CDS spreads. The difference in average spreads between these quintiles in terms of basis points is 140bps.
According to MSCI and Sustainalytics data, ESG factor performance has been positive relative to the broad market (here proxied by the S&P500 index) year-to-date. Constituents with the highest ESG scores (quintile 1) are consistently outperforming laggards (quintile 5) across all pillars on a market cap-weighted basis:
|
S&P 500 | Market Cap Weighted |
S&P 500 | Market Cap Weighted |
||||||
|
Q1 2020 Total Returns |
Quintile 1 |
Quintile 5 |
Spread |
Quintile 1 |
S&P 500 Index |
Spread |
|
|
MSCI Environmental Pillar |
-19.1 |
-21.6 |
2.5 |
-19.1 |
-21.0 |
1.9 |
|
|
MSCI Social Pillar |
-17.9 |
-21.3 |
3.4 |
-17.9 |
-21.0 |
3.1 |
|
|
MSCI Governance Pillar |
-16.4 |
-23.1 |
6.7 |
-16.4 |
-21.0 |
4.6 |
|
|
MSCI Overall ESG Score |
-14.8 |
-27.0 |
12.2 |
-14.8 |
-21.0 |
6.2 |
|
Source: S&P Global, MSCI, Federated Hermes
Importantly, this is not a sector specific phenomenon, with broad representation of ESG leaders outperforming in 8 out of 11 GICS sectors according to Sustainalytics:
Source: RBC, S&P Global, Sustainaytics, Trucost, Federated Hermes
The question remains as to why exactly these stocks have outperformed. Over the longer term, we can point to the creation of value for all stakeholders, including employees, customers, shareholders, bondholders, suppliers, the environment and wider society. Through a pandemic crisis, set to catalyse or accelerate potentially long-lasting implications for social and environmental issues, perhaps investors ascribe even greater weighting to the importance of these factors?
On the social side, major societal challenges - of healthcare resilience, the welfare of service and gig-economy workers, and the misery caused by social inequality – have gained new prominence in the international consciousness.
From an investment perspective, people have postulated that ESG factors are merely proxies for elements of quality and momentum. While healthy cash flows, a robust balance sheet and strong earnings would all feature alongside sound corporate leadership and strategy, this crisis has demonstrated the importance of social responsibility in the context of companies’ ability to survive – and thrive over the long-term.
