ESG Stock Performance Shows Sustainability Is More Important Than Ever

2020 was a year like no other for ESG funds. Investment strategies that take environmental, social, and corporate governance factors into account recorded a level of inflows that’s incomparable to any other year on record - with just over ⅓ of inflows into global funds being invested using ESG strategies - rising to more than half in the months of June and July. 

By September, global inflows into sustainable funds continued their momentum, reaching values of $80.5 billion while assets in sustainable funds reached an all-time high. Statistics show that the money coming into these funds have been invested well, too, with 40% of ESG and sustainable funds reaching the top quartile returns in the first half of 2021 - whilst Trustnet data suggests that the average ESG has been outperforming more traditional stocks over the same timeframe. 

But what’s propelling this unprecedented level of growth in ESG stock performance? It’s certain that the COVID-19 pandemic has played a key role in the spike in inflow, as investors look for sustainable investments that are more likely to stand strong in the face of a jittery market. According to Hortense Bioy, director of sustainability research at Morningstar, “the disruption caused by the pandemic has highlighted the importance of building sustainable and resilient business models based on multi-stakeholder considerations.”

(Image: Russel Reynolds)

As we can see from the data above, sustainable ETF assets under management have doubled in terms of value held between 2019 and 2020 - with Europe and North America leading the ETF market during the peak of the health crisis. 

While ESG stocks made significant inroads towards the mainstream in 2020, they will emerge as a dominance force in 2021. 

As we begin to slowly emerge from the pandemic, the role of ESG stocks will come into the spotlight more than ever as investors continue to build their confidence and shape their portfolios ahead of the age of the ‘new normal.’ With this in mind, let’s take a deeper look into how sustainability has developed to become more important than ever in the world of investing:

What is ESG Investing?

ESG investing relates to investing in companies that score highly when it comes to environmental, social and responsibility scales, which are graded and determined by independent third parties and research groups. 

Hank Smith, Head of Investment Strategy at The Haverford Trust Company said that “the underlying premise is that there are certain environmental, social and corporate governance factors that actually impact business. Considering those factors gives investors a more holistic view of companies, which can help mitigate risk and identify opportunities.”

So how does a company score highly when it comes to ESG grading? Let’s take a closer look at the three criteria in which businesses need to comply: 

Environment: This criteria scrutinizes a company based on the impact they have on the ecosystem. This can include the carbon footprint of a business, the chemicals used in the products it manufactures, and its sustainability efforts involved within the company’s supply chain. 

Social: This looks at how companies improve their social impact - whether it relates directly to the company’s actions or its influence over the broader community around the business. These factors can include LGBTQ+ equality, matters of diversity among executives and employees, and inclusivity within the hiring process. This criteria can even assess how a company behaves as an advocate for social good around the world in a wider context. 

Governance: Away from its social and environmental impact, the criteria of governance assesses how a company’s board and management work to create positive change. This criteria can include anything from issues regarding executive pay to diversity in leadership and how companies interact with its shareholders. 

With these criteria in mind, it’s clear that ESG investments extend way beyond matters of the environment, and that they consider key issues surrounding inclusivity, equality and positive drivers for change. 

COVID-Driven ESG Investing

Sentiment surrounding ESG investing as an ethical market alternative to traditional stocks was already growing in popularity prior to the arrival of COVID-19, but the acceleration that this movement experienced once the pandemic hit was highly impressive. 

According to Andy Howard, head of sustainable research at Schroders Investment Management, the pandemic is likely to generate new levels of interest in sustainable trends surrounding employee protection and other largely ethical initiatives. In the US, over 40 million people filed for unemployment protection, with minority workers faring worse from the rising number of individuals losing their jobs. “That’s not a new trend; we’ve been talking about it for a while,” Howard explained. “But effectively the coronavirus crisis is starting to crystalize some political actions trying to accelerate the reversal of some of those trends.”    

Furthermore, the economic downturn that was driven by the health crisis helped to expose some of the dangers of prioritizing policies beneficial to shareholders like dividends and buybacks. As a result, a number of companies have already begun cutting dividends as businesses begin to struggle in the wake of the pandemic - while buybacks also appear set to slow down. 

(Image: S&P Global)

As the data above shows, this COVID-driven sustainable investment trend has caused a number of ESG funds to outperform the S&P 500 - with some top performers experiencing one-year growth of over 50% since the initial outbreak of the pandemic. 

Investor Profiles are Changing

November 2020 was a time of great optimism in the battle against the spread of COVID-19, and as news of vaccine breakthroughs spread around the world, Calastone data shows that the UK experienced its biggest flow into active domestic equity funds in five years - and the second biggest since records began. 

Out of a total of £2.3 billion, £1.6 billion of cash reached active funds, whilst roughly £700 million arrived in passive funds - the same level as the year prior. The £820 million of new capital that was added by investors into ESG funds was more in the space of a single month than the past five years to January 2020 combined. 

Alongside these astounding inflows, Barclays research found that more women and Generation Z investors are beginning to make their presence felt in the investing arena, choosing to invest the money they’ve saved during months of lockdown. Evidence suggests that both groups are willing to prioritise ESG shares as a key part of their investment strategy. 

Barclays is optimistic that the changing face of investors may help to ensure that ESG investing is a long-term trend rather than a passing fad, and that the encouraging recent performance of sustainable funds “may mark its turning point for overwhelming adoption across investors.”

What’s encouraging for ESG markets is that the trend of investors demanding more access to sustainable shares is spilling into the world of consumerism, with shoppers increasingly intent on buying sustainable goods and services in the wake of the pandemic. 

With data suggesting that 34% of consumers have already admitted to intentionally paying more for ‘green’ products in the wake of COVID-19, there may not only be room for ESG stocks on public markets, but there could also be space for their products in the shopping bags of consumers around the world. 

Businesses are already wising up to the demand for more sustainable products, and we can take the world of eyewear as a prime example of an industry that’s already beginning to change how it markets itself to consumers. Lately, Vogue has paid out on a high-profile advertising campaign featuring NFL icon Tom Brady promoting biodegradable sunglasses. By introducing sustainability to a global market, Vogue is looking to capitalise on consumers shopping ethics as well as the look. Considering the fact that 75% of the adult population need some form of vision correction, there are billions of glasses in circulation (most of which are made of plastic), which carries a significant footprint on the environment. 

(Image: McKinsey)

McKinsey data confirms that consumers are already altering their behaviour in the wake of the COVID-19 pandemic as a means of upholding their values surrounding sustainability. This trend helps to illustrate the level of sentiment that’s spilling into investment markets as ESG stocks continue to outperform. 

Future-Proofing Portfolios

Research conducted by Morningstar shows that companies embracing sustainable business models like the embracing of low-carbon technology and ethical treatment of employees are more likely to be seen as future-proofed whilst leveraging more consistent cash flows. 

Furthermore, a study from HSBC notes that ESG issues contribute to around 43% of the key medium-term financial performance drivers. So does this evidence point to the necessity of businesses embracing sustainability as a means of future-proofing the investments of their clients? 

It’s clear that the topic of sustainability is more important than ever before, and this trend has only been accelerated by the COVID-19 pandemic, where investors and consumers alike have been handed a significant global event that’s offered the chance to refresh their global views and purchasing habits. 

The rise of sustainable products and the outperformance of ESG funds illustrates a movement that’s set to continue to gather momentum over the coming years as we emerge from the health crisis and enter the age of the new normal. With this in mind, we could well see investor portfolios that have spared consideration for sustainability faring better in the future than their more traditional counterparts.