ESG outperformed strikingly during the recent market meltdown of equity and bonds issued by companies with high scores within those asset classes. This is the clearest example yet of the ability of the sector to deliver superior financial performance and an indication of a shift in the institutional asset management community zeitgeist.

According to newly published research from Fidelity International, on the way down in the fastest bear market in US capital markets history - a decline of 27% hit over a period of 36 days, between February 19 and March 23, in the S&P 500 - equity and fixed income securities issued by companies at the top of Fidelity’s sustainability rating scale dropped less than the index while those at the bottom exceeded its decline.

The equity of companies rated A or B on the ESG in the company’s proprietary sustainability scoring model performed on average 3.8% better than the S&P during the market rout, while those rated C to E performed 7.4% worse.

“No asset was spared as the severity of the economic shutdown needed to contain the coronavirus outbreak became apparent to investors. The quickest US bear market in history, from February to March this year, was also the first broad-based market crash of the sustainable investing era,” says Jenn-Hui Tan, global head of stewardship and sustainable investing at Fidelity International.

“Our thesis, when starting the research, was that the companies with good sustainability characteristics have better management teams and so should outperform the market, even in a crisis. The data that came back supported this view.”

Meanwhile the same ESG-outperformance phenomenon was witnessed in the fixed income secondary markets, where from the start of the year to March 23, bonds issued by companies with high ESG scores outperformed their lower rated peers returning -9.23% on average for those rated A, versus a -13.2% return for bonds issued by B-rated companies and -17.14% for those rated C.  

“While some caveats remain, including adjustments for beta, credit quality and the sudden market recovery, we are encouraged by evidence of an overall relationship between strong sustainability factors and returns, lending further credence to the importance of analyzing ESG factors as part of a fundamental research approach,” says Fidelity’s Tan.

Fidelity’s scores were based on a performance comparison across more than 2,600 companies, and its forward-looking ESG ratings are derived from direct engagement with companies, comprising around 15,000 discrete company meetings per year.

“The recent period of market volatility was shocking in its severity. A natural behavioural reaction to market crises is to lower investing horizons and focus on short-term questions of corporate survival, pushing longer term concerns about environmental sustainability, stakeholder welfare and corporate governance to the background.”

“But this short-termism would indeed be short-sighted. Our research suggests that, what initially looked like an indiscriminate selloff did in fact discriminate between companies based on their attention to ESG matters.”

Fidelity’s research comes at a time for mixed signals within ESG. Whereas the EU has taken a step back from implementing its ambitious zero emissions policy, the “S” element of ESG is taking centre stage as governments and corporations rush to address the social fallout from Covid-19 and its impact on employment and mental health.

“Covid-19 underlines the importance of sustainability to the investment industry. If they ever did, financial markets no longer exist in isolation from social or environmental challenges. Companies’ fortunes are intrinsically tied to their ability to navigate changes in the societies on which they rely,” says Andrew Howard, head of sustainability research, ESG, at Schroders in London.

“Social and environmental challenges, as investment drivers, are increasingly overlapping. Environmental and social problems are increasingly clear financial risks, moving up corporate agendas to drive long-term strategy and growth plans. As investors, our ability to examine companies and separate winners from losers has improved as corporate sustainability reporting has become mainstream.”

As the Covid-19 onslaught has unleashed trillions of dollars of government, multilateral and corporate capital in the fight against its devastating economic impacts, not only has there been intense focus on the basic structure of capitalist societies, the role of government and other intermediaries as mitigators of unprecedented economic and social devastation, but it has also brought to the fore the challenge of climate change and sustainable economic development. An alignment with ESG is unfolding on multiple levels.

"This research demonstrates the reality that ESG-oriented investing delivers superior financial returns, and also that the sector has been able to weather the most brutal and fast-unfolding bear market in living memory, a stern test indeed,” says Fiona Reynolds, CEO of the UN-supported Principles for Responsible Investment, which promotes the use of ESG as an investment discipline among asset managers and owners globally.

PRI signatories - which at the last count collectively represent assets worth US$86 trillion - are considered to be a reliable objective indication of the growth of ESG. To the end of March, the PRI’s signatories rose by 26% globally, whilst within APAC there was 45% growth of asset managers and owners who signed up to the Principles. 

“The market outperformance reflects the fact that companies which pay heed to ESG inputs in general have highly engaged management teams as well as underlining in stark terms not only the resilience of securities aligned with ESG against market downside but also the ability of ESG ratings to capture the upside potential of these companies in alpha terms against the performance of benchmark indices,” says the PRI’s Reynolds.