A green approach when screens turn red? Wang Ying/Xinhua News Agency/PA Images
Bear markets test not just the resolve of investors but the performance of favoured investing strategies. Before the recent slump in share prices prompted by coronavirus, sustainable investing was in vogue. Does the green approach still make sense now that trading screens have turned red?
Sustainable investment means in practice the use of ESG (environmental, social and governance) criteria in investing, especially in equities. This was once a minority pursuit owing to concerns that green virtue might pay a price in lower returns. But in recent years it has won new fans in high places. In early 2019 BlackRock, the world’s biggest asset manager, said: “We have arrived at a ‘why not?’ moment in sustainable investing.”
That revelation was based on in-house research showing that the performance of ESG portfolios since 2012 matched or exceeded traditional ones. Returns in both developed and emerging markets were as good or better for the same amount of risk. An IMF study in October found broadly comparable performance between sustainable and mainstream global equity funds, showing that at any rate ESG investors did not pay a price for their principles.
These findings emerged as equities continued to march ahead in the bull market that started in 2009. But that long progression, underwritten by confidence that central banks were underpinning asset prices, has ended. The slump in share prices that started in late February has overwhelmed central banks’ interventions with the swiftest-ever descent into a bear market (when prices fall at least 20 per cent below their high). The test for sustainable investment is an exacting one. How has the strategy fared in precipitously falling stock markets rather than rising ones?
Sustainable funds have not been spared a battering. But analysis covering the period between 13th February and 12th March from Morningstar, an American investment research firm, found that ESG index funds outperformed mainstream equity benchmarks in the US, other developed markets and emerging markets. The margin was admittedly slim—for developed markets outside the US, an average decline of 25.9 per cent against a benchmark fall of 26.8 per cent—but on the right side of the scales.
Sustainable investing still has sceptics who doubt the meaning of ESG scores. These scores differ from familiar credit ratings provided by agencies such as Standard & Poor’s in two ways. Credit ratings correspond broadly with how likely it is that a firm or government issuing debt may default on it. Such probability is quantifiable on past experience. By contrast, ESG scores lack any identifiable link with corporate performance.
Credit ratings are also similar across the four big agencies providing them. By contrast, ESG scores are not consistent across the specialist outfits that have sprung up to gauge them (some of which have been acquired by the credit agencies as they themselves move into the field). Researchers at MIT have labelled this inconsistency “aggregate confusion.” They attribute just over half the discrepancy to ESG raters measuring the same categories differently. Most of the remaining inconsistency is because they select different ESG attributes for scoring.
For all the concerns about metrics, sustainable investing is here to stay. Finance is turning green partly under pressure from governments and partly because of the risks of investing in firms such as oil producers whose businesses may be up-ended by steps taken to combat climate change. There is generational pressure, too, since millennials are particularly keen to invest sustainably. At some point, depressed equity prices will represent a buying opportunity and that should apply to ESG funds as much as, if not more than, conventional investments.
