ESG OUTLOOK (part 1)

Sustainable development:
a worthwhile pursuit no matter the circumstances

by Ophélie Mortier,
Sustainable & Responsible Investment Strategist at DPAM


At first glance, the integration of environmental, social and governance (ESG) factors seems to be a relatively new phenomenon, especially when compared to the lengthy existence of financial analysis models that govern the investment world. In fact, it is rather the popularisation of the term “ESG integration” that is recent. Indeed, many analysts and active managers were already applying ESG factors in their fundamental and qualitative analyses long before it entered investors’ lexicon. However, at that time, they were quite unaware that a specific term would eventually combine these criteria under a single name. The 2008-2009 crisis, though quite different from the current crisis, already emphasised the benefits of ESG integration in management. However, investors were initially sceptical about this “new” financial approach. Back then, it was neither standardised, nor regulated. As such, investors wondered whether there were other variables that could explain the good performance of these so-called sustainable companies. They looked at factors such as a company’s sector of economic activity and its size or the funds’ management style (typically value versus growth).

The pandemic and its major consequences on the global economy have demonstrated – once again – that companies deemed ‘sustainable’ have been more resilient from an accounting and financial perspective. In addition, they outperform the financial markets.

This superior financial performance has not only been reflected through the companies’ superior returns, but also through their risk profile.

It does not matter whether the observations are made on the European-, American- or Emerging markets, the conclusions remain the same: higher alpha and lower risk (i.e. lower risk of bankruptcy, downward revisions of profitability forecasts, yield volatility, etc.).

Graph 1: ESG indices in Europe fell less than their corresponding regional indices

Source: bofA European Equity Strategy; Bloomberg
Copyright © 2020 Bank of America Corporation (“BAC”) below*

These sustainable companies have also shown superior resistance during periods of economic uncertainty. Moreover, the funds which invest in these specific companies have also shown a greater resistance to investment flows in times of liquidity crises and panic-driven sales. This investment flow stability is a potent asset, which improves the management of the risk/return ratio.

Graph 2: US-focused ESG funds continue to gain assets even during the downturn

Source: bofA US Equity & Quant strategy, SimFund
Copyright © 2020 Bank of America Corporation (“BAC”) below*

Graph 3: European-focused ESG funds continue to gain assets even during the downturn

Source: bofA European Equity Strategy, EPFR
Copyright © 2020 Bank of America Corporation (“BAC”) below*

Sustainable corporate engagement, as well as the integration of environmental and social issues cannot be considered a luxury for profitable and healthy companies in favourable and buoyant market conditions.

In addition to being financially successful, these firms are also sustainable and environmentally friendly in the global sense. Indeed, there is a reason why these companies are healthy and profitable. Namely, they have also integrated the stakes (i.e. the risks, but also the opportunities) of sustainable development at the highest levels of their governance bodies. Moreover, the respect of their stakeholders’ interests has generally also been fully integrated within the company. In times of turmoil and uncertainty (like those which we are experiencing today), investors and companies are asked to meet the needs of their stakeholders. As such, they have to adjust their portfolios, business segments, operations, etc. accordingly. In this context, the integration of ESG issues can grant a major competitive advantage.

Relatively expensive companies versus interesting investment opportunities at a lower price following the market correction.

After the recent market correction, investors have been eyeing the markets for investment opportunities. For example, after the drastic fall in oil prices, the oil sector certainly seemed rather attractive, especially when compared to other companies that have shown better resistance to the correction (e.g. companies that are generally more ESG-focused). Could there be a risk that ESG-focused companies will suffer because of supply and demand effect? Could it be that companies or sub-sectors that are typically underrepresented in ESG strategies will outperform their sustainable counterparts? Will a stock market rally hurt sustainable funds in relative terms?

No. This fear is neither justified, nor has it ever been substantiated over the medium- or long-term. Sustainable and responsible investments focus on investing with conviction, and with an eye on value creation in the medium- to long term. As a result, these investments are not meant to exploit ephemeral bubbles or consider temporary opportunistic acquisitions. On the contrary, they are designed to support companies in their winning strategy of value creation. In doing so, these sustainable companies take into account upcoming innovations and future opportunities, and anticipate all potential risks.

Towards a common language?

Numerous articles, comments and studies have highlighted the excellent performance of sustainable and responsible investments, and the notable resilience of sustainable companies. This is an important step in the integration of ESG factors in finance. Many claim to integrate these factors into their management processes. However, as those who are most involved on the topic of sustainability know all too well, this integration is neither easy nor universal. It demands rigour, discipline, critical analysis and in-depth research. Above all, it also requires the investor to engage in an active dialogue with its companies. If the crisis marks an additional infatuation with the movement and structural trend of the last decade, we hope that, most of all, it will lead to a shared willingness to speak the same language. Today, we already have initiatives that advocate a more unified and standardised corporate language on ESG. Unfortunately, like the extra-financial rating agencies, these initiatives are diverse and end up proposing different languages themselves. Regulators are trying to help. They not only try to ensure the transparency of information for investors in sustainable and responsible products, but also for the professional investor in sustainable and responsible companies. Regulation is constantly growing and is accompanied by a multitude of advantages and weaknesses. We will have the opportunity to further elaborate on this in the fourth article of this series. What is certain, however, is that these regulations are here to stay. Consequently, it matters little whether we believe that sustained commitment has become a crucial element of asset management. Regulation will likely have the last word.

*Reprinted by permission. Copyright © 2020 Bank of America Corporation (“BAC”). The use of the above in no way implies that BAC or any of its affiliates endorses the views or interpretation or the use of such information or acts as any endorsement of the use of such information. The information is provided “as is” and none of BAC or any of its affiliates warrants the accuracy or completeness of the information.


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