Are ESG funds resilient?

ESG fuds

FUNDS with environmental, social and corporate governance (ESG) mandates were found to have delivered better returns to investors in a volatile 2020 as compared to conventional funds.

But does this necessarily mean ESG funds are more resilient than conventional funds?

According to Refinitiv Lipper head of EMEA research Detlef Glow, it remains unclear if ESG-related strategies were superior to conventional investment strategies.

While he generally agrees that ESG-related funds may have a better resilience during rough market periods and can deliver a higher outperformance compared to conventional funds based on last year’s data, he notes that 2020 was an exceptional year, which makes it hard to compare the results for 2020 with a blueprint from other years.

“Some of the factors that might have influenced the performance of conventional and ESG-related products might have been single events or can change immediately from one side to the other. One example of this can be seen in the drop of the price of oil, which has massively impacted some conventional funds, while ESG-related funds would normally not invest in fossil fuels, ” Glow explains in his note.

“Another performance driver was the general trend towards growth stocks from the new economy. This might have also favoured ESG-related strategies since a number of these stocks are also the favourites of ESG investors because these companies do often show a better ESG performance than industrials or other companies from the old economy, ” he adds.

Therefore, at least some parts of the superior performance of ESG-related funds must be attributed to market circumstances.

In other words, once investors start to favour value stocks, which are often found in sectors known for their high consumption of fossil energies, the performance pendulum may swing back to non-ESG-related funds, Glow argues.

Indeed, 2020 was a challenging year for the global economy because of the Covid-19 pandemic, which led to governments around the world closing their borders and implementing nationwide lockdowns around late first quarter to prevent the spread of the virus in their countries. This, however, resulted in a major sell-off in the capital markets, and amid the fallout, the prices of crude oil even fell below zero for the first time in history.

To battle the headwinds of Covid-19, governments worldwide had also unleashed unprecedented levels of fiscal and monetary stimulus, which in turn, helped markets bounce back strongly.

“Since resilience to market downturns is one of the key drivers for the success of an investment strategy, it is still not clear if ESG-related strategies are superior compared to conventional investment strategies, ” Glow says.

“However, it has been proven that some measures on the governance of companies can reduce the overall risk of defaults in a portfolio. But these measures are not exclusive to ESG-related strategies, ” he adds.

In its analysis of 14,801 actively managed funds (conventional and ESG-related), Refinitiv Lipper finds 7,574 funds (51.2%) delivered an outperformance, while 7,227 (48.8%) underperformed their respective fund manager benchmarks last year.

Under the 12,898 conventional funds, 50.3% beat their respective fund manager benchmarks, while 49.7% showed an underperformance over the course of 2020.

As for the 1,903 ESG-related funds, 57.2% showed an outperformance, while 42.8% underperformed their respective fund manager benchmark.

Between Jan 1 and Dec 31 last year, ESG-related funds showed a higher overall average outperformance of 3.78% compared with that of conventional funds at 2.15%. A closer look at the performance pattern shows that ESG-related funds did not only show a better average outperformance (11.75%) compared to their conventional peers (11.45%), but they also showed a lower underperformance (-6.83% versus -7.25% for conventional funds).

“These results may indicate that actively managed ESG-related funds are able to deliver better results than their conventional peers as they showed a higher percentage of outperforming funds, a better average outperformance, and a lower underperformance over the course of 2020, ” Glow says.

He notes that while most investors see negative returns in general as bad results, most asset managers measure the risk of their portfolios relative to their benchmark or index. This means most asset managers will evaluate a negative performance as a success as long as the negative returns are better than those of the respective index or benchmark.

“Therefore, it would make sense that asset managers would implement some risk measures with regards to the absolute performance of their funds to align the interest of investors with the targets of the portfolio managers, ” Glow explains.

“Taking the absolute performance into consideration would also help to increase the resilience of a fund since the portfolio manager could use cash as a risk buffer, ” he adds.

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