Sustainability in the age of coronavirus
The recession caused by the novel coronavirus has a lot of losers, but at least one (temporary) winner: the environment. The emergency shutdown of the world economy looks destined to lead to a drop in worldwide CO2 emissions for the first time since the 2008 financial crisis. However, the public health crisis could cause the “green wave” seen in recent years to lose momentum. What does look set to stay firmly in place, though, is the trend toward sustainable investing. Focusing on environmental awareness, social aspects and good corporate governance (issues known by the acronym ESG) is becoming increasingly important to investors. Sustainability and a good risk-adjusted return performance are by no means contradictory. In the recent downturn on the equity markets, sustainable assets have once again proven their defensive qualities.
The environment breathes a sigh of relief
The global public health crisis and the inevitable coronavirus recession have precious few positive aspects to take pleasure in, but there is at least one piece of good news: the environment can breathe a sigh of relief for the moment. The restrictions on freedom of movement that have been imposed by now on approximately 2.5 billion people around the world are exerting an impact not just on the spread of the coronavirus, but also on our planet’s ecology. Be it clear water in the lagoons of Venice, birds chirping merrily in London or (nearly) smog-free skies over Milan – the effects of the forced interruption of tourism, the sharp reduction in traffic and the drop-off in energy production are audible and visible.
These salubrious developments for the environment can also be expressed in numbers. Gasoline sales in the USA are down 48% year-on-year as they recently plummeted to their lowest level in three decades. Daily exhaust emissions in Europe have fallen 58% from their pre-crisis level. Worldwide carbon dioxide (CO2) emissions look set to decrease this year for the first time since the 2008 financial crisis.
The current developments illustrate just how tightly economic growth and humanity’s ecological footprint are still interlocked.
Climate change faces a risk of fading from view
The coronavirus pandemic has brought about a beneficial short-term decrease in environmental stress, but the ongoing crisis now threatens to overshadow preexisting environmental concerns for quite some time to come. UN negotiations on a new climate target accord have been postponed for the time being. The European Union’s agreement on an ambitious emissions goal for 2030, which until recently had been just a simple bureaucratic arithmetic problem, may now prove to be a more difficult undertaking. For the next six to twelve months at the least, the political agenda is likely to revolve first and foremost around combating the coronavirus and engineering an economic recovery. Because however nice the beneficial side effects for the environment are at the moment, the current developments illustrate at the same time just how “expensive” a permanent change in environmental consciousness is and just how tightly economic growth and humanity’s ecological footprint are still interlocked at present.
The coronavirus crisis hit us right at a time when the climate movement was gaining considerable momentum. Greta Thunberg sparked an awakening or intensification of environmental awareness in growing swaths of the public last year. The European Commission named a “green deal” as one of its top priorities, and climate stress tests and “green quantitative easing” were even being talked about in central-bank circles. But in the face of the pandemic, climate change will now probably seem like only a distant threat to many. A study conducted by the University of Connecticut in 2012 revealed an inverse correlation between public concerns about the environment and public concerns about the economy. Against this backdrop and given the impending severe recession, which is likely to eclipse the magnitude of the economic downturn during the financial crisis, it arguably will be quite a while before the topic of climate change rejoins the broader public’s list of biggest concerns.
Sustainability is becoming even more important to investors
However, what will continue to pick up momentum in the wake of the coronavirus crisis is the trend toward sustainable investing. The initials E, S and G (which stand for environmental, social and governance) had already gained increasing significance for investors in recent years, but now the pandemic is demonstrating in real time (and in a personally tangible way for many) just how important aspects of good corporate governance such as disaster preparedness and continuity planning or social factors like paid sick leave and mobile work options are in actual real-world practice.
Continual upward trend
Growing investor community and expanding assets
Assets under management and number of PRI signatories
The growing importance of ESG factors to institutional investors is vividly reflected in the volume of assets managed by the signatories to the Principles for Responsible Investment (PRI), a sustainability-minded honor roll that includes Kaiser Partner Privatbank. Assets under management by PRI signatories have surged from USD 6 trillion in 2006 to USD 86 trillion as of end-2019. The sustainable investing style has continued to enjoy popularity, even during the “corona-crash” in February and March this year. While investors withdrew EUR 30 billion from European standard ETFs between February 21 and March 31, ESG-focused ETFs registered an aggregate net inflow of EUR 2 billion.
ESG stands the test
Investors who wish to gear their portfolios toward sustainability do not necessarily have to sacrifice a good return performance. A study by Morgan Stanley of the years 2004 through 2018 showed that equity funds with an ESG focus achieved returns similar to those earned by conventional equity funds, and they even moderately outperformed their conventional counterparts during down market periods. The performance of sustainability stock indices also confirms the defensive qualities of shares of companies that operate sustainably. For example, index provider MSCI’s ACWI ESG Leaders Index, which includes companies with above-average ESG ratings from around the world, consistently outperformed the conventional MSCI All Country World Index during the market corrections in 2008/2009, 2011, 2015 and 2018.
“Sustainable stocks” exhibit strength during market corrections
MSCI ACWI ESG Leaders Index (relative to MSCI ACWI Index)
The increasingly popular sustainable investing style has passed yet another performance test with flying colors in recent weeks. During the crash in the first quarter – the fastest bear market in history –, sustainable assets once again exhibited relative strength. Stocks rated best-in-class in terms of ESG criteria (ESG Leaders) significantly outperformed stocks with poor ESG ratings (ESG Laggards) in the first quarter in both the USA (S&P 500 index) and Europe (STOXX 600 index).
A good ESG rating pays off
ESG Leaders vs. ESG Laggards in Q1 2020
Source: Analysis by Kaiser Partner Privatbank
But why do sustainable equity investments often fare better than the broad market? Stock factors and sector affiliations are part of the explanation. Shares of companies with high ESG ratings, for example, fall under the categories of momentum, low-volatility or quality stocks more frequently than average and appear less often in the category of value stocks. Moreover, in the universe of stocks with high ESG scores, the technology sector in particular is overproportionately represented, whereas the energy industry is underrepresented. This means that the high ESG-rating bracket features a preponderance of the exact same styles and sectors that performed better than average during the bull market since 2009 (and during the recent correction as well). Another part of the performance discrepancy between sustainable and non-sustainable assets likely owes to the premium that investors are willing to pay for shares of more sustainable companies and the discount they demand for shares of less sustainable enterprises. Since the trend toward sustainable investing continues unabated and ever more capital is flowing into this asset segment, the valuation premium for ESG Leaders looks destined to increase further in the future.
The sustainable investing style once again successfully put its qualities to the test during the recent “corona-crash”.
The upshot: The coronavirus crisis demonstrates that it is within our power to at least slow down climate change, though doing so comes at a certain cost. Although the economic crisis has now pushed other issues into the foreground for the time being, we shouldn’t lose sight of environmental (E) protection. Everyone can do his or her part. The public health crisis also renders tangible what social (S) aspects and good corporate governance (G) really mean in actual practice. Companies that pay inadequate attention to ESG factors are likely not only to face competitive handicaps, but are also bound to see their attractiveness for investors further diminish.
By choosing a sustainable investment strategy, investors ideally can accelerate the transition to a more sustainable society without having to forgo a good risk-adjusted return. The sustainable investing style once again successfully put its qualities to the test during the recent “corona-crash”. Kaiser Partner Privatbank has been managing client assets in line with this investment philosophy already for more than a decade. To enlarge our offerings for clients, this year we have set up a new, dedicated sustainability discretionary mandate that not only integrates sustainability aspects, but also optimizes the overall ESG rating and minimizes the CO2 footprint.