Environmental, social and governance initiatives have gained traction in many companies
Advocates of environmental, social and governance (ESG) investing have long maintained that strong ESG practices contribute to strong businesses. COVID-19 has put that thinking to the test, and over the past few months, we’ve seen several bright spots in terms of ESG engagement and performance.
ESG engagement: Companies seek meaningful changes during crisis
The United Nations Principles for Responsible Investing (UNPRI) has historically experienced above-average growth in membership during times of crisis, like during the financial crisis of 2008-09. The current crisis is no exception. The UNPRI has seen a 28% increase in the growth of its signatories already this year, making 2020 the best year since 2010 – and we’re not even halfway done.1 Companies are using this crisis to make meaningful changes, not just to adapt to COVID-19-related challenges, but also to improve their environmental, social and corporate governance policies; to increase technological investments that improve their resiliency; to build trust with employees, customers and shareholders; and to ultimately come out of this crisis stronger and better positioned.
From an environmental perspective, nature has been one of the biggest beneficiaries from a global pause in travel and movement. Pictures of typically smoggy cities around the world now show clear, clean air. While some level of activity will undoubtedly return over time, many companies and employees are learning how productive home offices, remote meetings and virtual conferences can be. Moreover, the work-from-home transition has accelerated the transformation towards paperless offices, helping many break the habit and dependency of printed material.
Socially, there have been two big areas of change this year. The first is COVID-19-related: Many companies have had to reimagine their working conditions – ensuring a healthy work-life balance for employees working from home, as well as creating a safe environment for employees and customers at the office or job site. The second relates to social justice. It’s become increasingly clear that not enough has been done to close racial gaps and disparities that have existed for decades, and it’s been encouraging to see the new or renewed public declaration of initiatives by various companies to help address this issue.
ESG performance: Comparing results by company engagement
What about performance? Advocates believe that companies with better ESG practices and engagement are well-positioned to outperform peers with lower levels of ESG engagement. One of the hardest parts about evaluating whether this is true over the long term is that ESG has only taken off in broad scale in the US within the last 10 years. The past decade has also been one of the best decades for stock market returns, so there hasn’t been a meaningful pullback to try and identify whether the aforementioned was actually true: Do companies with higher levels of ESG engagement outperform their peers?
While the markets have certainly been turbulent this year, we believe it’s still worth exploring the returns of highly engaged ESG companies and their peers. Let’s look at the 12 months ending June 30, 2020 and compare the performance of S&P 500 Index constituents from the top-ranked ESG companies (Quintile 1) through the lowest-ranked (Quintile 5).
It’s clear that the Quintile 1 companies outperformed the other groups. At a granular level, these companies were less volatile through the turbulent March-April period, which helped overall performance. Looking at the rest of the list, the other quintiles almost fall in perfect line (in terms of higher ESG scores equating to higher performance) with one exception – the lowest quintile group ranked in second place in terms of performance over the past year. Why? That group’s performance was dominated by one of the largest companies in the S&P 500 – Amazon (NASDAQ:AMZN) – which contributed over half of the return for that group.2 But besides that exception, the higher-ranked companies from an ESG perspective have outperformed lower-ranked companies.
When you pause for a minute and peel back the ESG layers to try and understand why it is that these companies tend to outperform, I believe it lies with the management teams – the often-overlooked non-financial component of fundamental analysis. The quality of a management team can quickly be overshadowed by artificial intelligence, machine learning and algorithmic trading. However, it’s the management teams making key decisions with the long view in mind that drive the E, S and G forward, ultimately for the betterment of not just shareholders, but the world.
1 Source: UNPRI
2 Amazon was not a holding of the ESG Opportunity Portfolio as of June 30, 2020
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ESG investing stands out during COVID-19 volatility by Invesco US
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