ESG Proves to Be Safe Haven During Times of Turmoil

Sustainable investing will sustain investment portfolios during times of market turmoil, according to BlackRock and Bank of America. Recent research from the firms shows that the majority of environmental, social and governance (ESG) investments outperformed their non-sustainable counterparts during the first quarter market crash.

BlackRock, which made sustainable investing the focus of its investment strategy earlier this year, said its research has found a correlation between sustainability and traditional factors such as quality and low volatility, which its says indicates resilience. As a result, the firm expects sustainable companies to be more resilient during downturns.

“In the first quarter of 2020, we have observed better risk-adjusted performance across sustainable products globally, with 94% of a globally representative selection of widely analyzed sustainable indices outperforming their parent benchmarks,” BlackRock said in a recent report. “While this short time period is not determinative, it aligns with the resilience we have seen in sustainable strategies during prior downturns.”

To demonstrate why sustainable funds tended to outperform during the crisis, BlackRock said it analyzed how different sustainability characteristics drive performance. It argues that traditional financial accounting standards do not provide investors with a complete picture of all the risks and opportunities companies face.

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“Armed with more information, investors are better positioned to evaluate risks,” the report said, “an advantage that is especially relevant in market stress periods when uncertainty about future outcomes is larger.”

BlackRock’s analysis is based on 15 so-called “descriptors” that focus on a different material sustainability issue, and their relevance to a company’s long-term prospects. The descriptors are: board effectiveness; waste management; audit, tax, and risk management; customer relations; energy production; culture; board independence; water management; clean technology; energy management; workers’ rights; talent management; community relations; ownership and control; and business ethics.

Each of the descriptors are intended to anticipate an adjustment to the expected growth rate of companies over the long term that market participants have not fully factored in. To test the descriptors, BlackRock created hypothetical portfolios for each one that was independent of other descriptors, such as a portfolio that examines the impact of board effectiveness, or one that shows the effect of energy management on returns. It also created a hypothetical portfolio that generates an overall sustainability assessment across all 15 descriptors.

BlackRock’s analysis of the descriptor portfolios showed that the overall sustainable portfolio generated a return of 1.5% from Jan. 1 to April 30, 2020, and that 11 of the 15 descriptors showed positive returns over that same period. It also found that resilience is stronger for descriptors that are identified with issues that mattered most to companies during the downturn. For example, the board effectiveness portfolio returned 2.4% over the period, while the customer relations portfolio returned 1.7%.

“We believe that we are still in the early stages of a persistent and long-lasting shift toward sustainability—the full effects of which are not yet included in market prices, given the long transition,” the report said. “We expect this gradual transition alone will carry a long-term return advantage for sustainable investors over years and decades—an added bonus to greater portfolio resiliency.”

Meanwhile Bank of America said its research has debunked the belief among ESG doubters that ESG is a “bull market luxury” and that during a downturn investors and firms will reallocate all resources just to stay afloat.

“Our contention has been that ESG is even more critical during a downturn, and recent evidence supports this,” Bank of America said in a report.

The report said ESG indices in Europe have outperformed their benchmarks year-to-date, and that the top 50 most overweighted stocks by ESG funds have outperformed the most underweighted by more than 10 percentage points year-to-date.

“Moreover, ESG funds are still tracking year-to-date inflows versus record outflows in equity ETFs [exchange-traded funds],” Bank of America said. It also said companies with low ESG ratings in the US, Europe, and Asia have seen larger downward earnings revisions for 2020/2021 expectations than higher ranked companies.

The Bank of America report also said ESG investments can generate alpha during market sell-offs, citing that stocks that rank in the top 20% of ESG metrics outperformed those that ranked poorly during the market sell-off during the fourth quarter of 2018 and during this year’s sell-off. It said that since the S&P 500’s peak in February, stocks in the top 20% by ESG ranks outperformed the market by more than 5 percentage points.

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Tags: Bank of America, BlackRock, Downturn, ESG, sustainable investing

The current state of play in stocks reminds Morgan Stanley’s Michael Wilson of March 2009, the turning point for shares after the 2008 financial crisis wipeout. So his outlook is bullish. Of course, unlike the 2007-09 bear run, the 2020 version went by in a blink.

Aside from bear market length, there are a lot of similarities. “Markets are tracking the Great Financial Crisis period very closely in many ways,” wrote Wilson, the firm’s US equity strategy head, in a note to clients. Just as in 2009, when stocks embarked on history’s longest bull market, they began a rebound this past March. Duration of recent slide: one month.

The bear market that accompanied the Great Recession was a lot longer than the current one. Last time, the air started going out of stocks in late 2007, and they really sank when the crisis hit in September 2008 and kept diving until the following March. Duration: 17 months.

Lately, things are happening very fast. The recent bear market began after stocks peaked Feb. 19 and went on to lose 34% (the technical definition of a bear market is a drop of at least 20% from the high point), until March 23. Then, as Congress passed a $2.2 trillion rescue program for the virus-whacked economy, the market roared back, gaining some 30%, and it’s now within hailing distance of its apex.

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Wilson checks off the many resemblances between then and now. The equity risk premium, of around 7 percentage points, is a near match, for instance. That’s the expected earnings yield—the inverse of the price/earnings ratio—for the S&P 500 minus the 10-year Treasury’s yield. The risk premium indicates how much additional return stocks garner over safe Treasury bonds’ performance.

Still, there are some significant differences in the components of the equity risk premium between today and 11 years ago: Both the earnings yield (7.7%) and the 10-year yield (0.7%) are lower nowadays (in 2009, they were 9.5% and 2.5%, respectively). Still, in Wilson’s eyes, the relationship between the two numbers in each year tells essentially the same tale. Namely, bluer skies ahead for stocks.

Wilson’s note displayed little patience for those who argue that the current rally is powered by a handful of tech darlings (Facebook, Amazon, etc.). He pointed to the outperformance of small-cap stocks during this spring rally, plus a rising percentage of stocks exceeding the 200-day moving average, as evidence that the upward move has breadth going for it, a good sign of stamina.

In a contrarian stance, Wilson believes interest rates will rise with an economy that will grow again, due to Washington’s coronavirus relief and a re-opening of US business. The conventional expectation is for low rates for a long time (the Federal Reserve has pegged short-term rates near zero). And climbing rates, the standard reasoning goes, are good for stocks, as bonds with their skimpy payouts are no competition. But Wilson thinks rising yields are the telltales of a growing economy and that condition is ripe for stocks.

And that would leave the 2020 bear market as the shortest in history. The record before was held by the 1990 bear, when it took only took three months to go from peak to trough, then began climbing again. The average bear market lasts 21 months.