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Stocks, bonds with higher ESG ratings outperform
Study finds strong positive correlation between market performance and ESG rating
5 Nov 2020 | The Asset

In the first nine months of 2020, a period heavily impacted by the Covid-19 pandemic, stocks with higher environmental, social and governance (ESG) ratings outperformed those with weaker ESG ratings in every month except April, according to new research by Fidelity International.

The study, whose timeframe covers both the market crash in March and the recovery from April onwards, suggests a strong positive correlation between a company’s relative market performance and its ESG rating, with each ESG rating group beating its lower rated group.

Jenn-Hui Tan, global head of stewardship and sustainable investing at Fidelity International, comments: “We’re pleased to observe the relationship between high ESG ratings and returns over the course of a market collapse and recovery. This supports our view that companies with good characteristics have more prudent management and will demonstrate greater resilience in a crisis.

“The market volatility of 2020 echoes that of 2008, despite the difference in circumstances. It would be natural to shorten investing horizons in a time of uncertainty and put longer-term concerns about environmental sustainability, stakeholder welfare and corporate governance on the back burner.

“But our research suggests that the market does, in fact, discriminate between companies based on their attention to sustainability matters, both in crashes and recoveries, demonstrating why sustainability should be at the heart of active portfolio management.”

Fidelity carried out the performance comparison across 2,659 companies covered by its equity analysts and 1,450 companies in fixed income, using the company’s proprietary ESG rating system. The forward-looking ratings are derived from direct engagement with companies, aggregating approximately 15,000 individual company meetings per year.

The findings in fixed income are similar to those in equity. The bonds of the 154 A-rated companies returned around -0.5% on average, compared with -1.5% for the 557 B-rated companies and -4.6% for the 225 D-rated companies, Fidelity says.

An exception to the rule came in April, when the groups with higher ESG ratings fell less as the markets collapsed and rose less when they recovered sharply compared with those with lower ratings. This suggests that stocks with higher ESG ratings also have a low-beta, high-quality factor and are less prone to volatility in the broader market.

While each ESG grouping outperformed the one beneath it in the ratings, most rating groups underperformed the MSCI index in view of the huge gains in the tech sector over the course of 2020. Tech stocks are dispersed throughout the company’s ESG ratings, from A to E, and as such, all five categories have not been able to keep up with the benchmark, Fidelity explains.

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