Companies that score better on environmental, governance and social (ESG) factors have outperformed during the recent market volatility cased by the Covid 19 pandemic.
Research by Fidelity International, using their own ESG ratings, shows that a company’s performance and this ESG rating are positively correlated, even in a crisis.
The equity and fixed income securities issued by companies at the top of Fidelity’s sustainability rating scale (A and B) on average outperformed those with average (C) and weaker ratings (D and E) in this short period, with a remarkably strong linear relationship.
In the 36 days between 19 Feb and 26 March, there was a sharp correction in stock markets around the globe, with the S&P 500 plunging by 26.9 per cent. Meanwhile, the price of a share in companies with a high (A or B) ESG rating dropped less than that on average, while those rated C to E fell more than the benchmark.
A-rated companies performed on average 3.8 percentage points better, while E-rated companies performed on average 7.4 percentage points worse than the S&P 500 during the period examined.
As a result Fidelity says that each ESG band was worth around 2.8 per cent of stock market outperformance, when compared to the index over this period.
Fidelity International’s global head of stewardship and sustainable investing Jenn-Hui Tan says: “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.
“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.”
The research from Fidelity International also found the fixed income securities of higher-rated ESG companies performed better than on average than their lower rated peers from the start of the year up to March 23, in an unadjusted basis.
The bonds of the 149 A-rated companies delivered a negative return over this period of -9.23 per cent on average. But B-rated companies saw a more significant loss, with average returns of -13.16 per cent over this period. Meanwhile the bond of C-rated companies delivered a return of -17.14 per cent.
Tan adds: “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 sell-off did in fact discriminate between companies based on their attention to ESG matters.
“It supports our view that a company’s focus on sustainability factors is fundamentally indicative of its board and management quality. This leads to more resilient businesses in downturns that will be better positioned to capture opportunities when economic activity resumes, more than earning its place at the heart of active portfolio management.”
Fidelity carried out a performance comparison across more than 2,600 companies for this research. Its forward-looking ESG ratings are derived from direct engagement with companies, aggregating approximately 15,000 individual company meetings per year.