Bear Markets, Pandemics and ESG Portfolios

Investment managers say evidence is already mounting to show an outperformance of ESG-themed portfolios during the coronavirus pandemic. Might that help their popularity in the U.S.?

Over the years, Michael Hunstad, head of quantitative strategies at Northern Trust Asset Management, has spoken numerous times with PLANADVISER about the evolving topic of portfolios themed around environmental, social and governance (ESG) issues.

Hunstad, who designed and oversees the firm’s “quality ESG” strategies, says the United States continues to lag behind Europe and other global regions when it comes to embracing ESG portfolios. In other words, ESG considerations have largely become table stakes in investment management discussions that are happening outside the United States.

According to Hunstad and others, one of the small silver linings of the ongoing coronavirus pandemic is the opportunity to demonstrate to U.S. investors why ESG matters. To this end, he points to performance data tied to his firm’s quality ESG strategies showing outperformance relative to non-ESG full market portfolios. 

“Our message is that combining quality metrics such as strong cash flow with ESG thinking can lead to outperformance versus the broad equity benchmarks,” Hunstad says. “Quality is an excellent complement to ESG.”

Growing Popularity Tied to Performance

Research from Morningstar finds most investors, across ages and genders, have clear preferences for ESG-conscious investment products. Morningstar suggests that 72% of the United States population expresses at least a moderate interest in sustainable investing. Institutional investors, similarly, have expressed a good measure of their own cautious but significant interest in ESG topics.

Tracie McMillion, head of Global Asset Allocation Strategy for Wells Fargo Investment Institute, says the growing U.S. consumer demand for ESG investments is “just the tip of a potential iceberg.”

“U.S. investors’ fundamental desire to align their investments with their personal preferences, combined with their lack of exposure to information about sustainable investing to date, points to significant growth in this market as consumer awareness grows,” McMillon says. 

According to Wells Fargo survey data, 25% of investors have heard a lot or a fair amount about sustainable investing funds, while 38% have heard only a little and 37% have heard nothing. Only 12% of investors say they have heard about sustainable investing from a personal financial adviser and 9% from an investment or fund manager. Among employed investors with a 401(k), just 4% have heard about sustainable investing through their employer’s 401(k) program.

The Wells Fargo data shows investors are already inclined to believe that sustainable investing funds perform well, with 69% believing they perform on par with the market average, far exceeding the 24% who think they perform worse. Another 7% believe they perform above par.

Hunstad says his firm’s quality ESG fund performance dispels the significant misperception that one needs to sacrifice returns to invest responsibly.

“Quality ESG or ‘QESG’ has continued to outperform during the current drawdown period independent of just the energy sector exposure or lack of,” he explains. “Through focusing on high-quality, highly rated ESG companies and incorporating several dimensions of risk controls to maintain appropriate levels of diversification, QESG has historically attained several goals around risk, return and ESG measures that investors should find desirable.”

COVID-19’s Specific Impact

When it comes to the pandemic’s potential effect on this discussion, Andrew Howard, head of sustainable research for ESG at Schroders, suggests governments should use the current crisis to “set a new direction in climate policy and a new leadership ambition,” nothing that climate change could eventually be a bigger threat than this crisis.

“The ultimate death toll from the COVID-19 pandemic looks certain to reach the hundreds of thousands,” he soberly observes. “As devastating as that is, the effects of climate change on health and mortality are potentially more drastic. The World Health Organization [WHO] has estimated that, between 2030 and 2050, unabated global warming will cause an additional 250,000 deaths annually from heat stress, malnutrition, malaria and diarrhea. The economic impacts of climate change will be similarly severe in the long term.”

Howard says the climate challenge has not generated a response that registers on the same scale as the response to the coronavirus.

“Major global economies have announced stimulus packages totaling more than $4 trillion,” he says. “That scale of fiscal intervention is about twice as large as the combined firepower those countries mustered in response to the global financial crisis. In this context, it also represents more than 10 times the annual global spending on efforts to mitigate climate change by the world’s governments.”

Howard concludes that the “ingredients for action” are in place.

“Public concern over climate change is comparable with coronavirus fears,” he suggests. “A United Kingdom survey in mid-March showed significantly more respondents were worried about the impact of climate change than of coronavirus on humanity. In the U.S., surveys in recent years have consistently shown as much or more concern over climate change than for pandemic outbreaks. The choices political leaders make in the next few months will be important. They have an opportunity to use the window presented by the current crisis to inject similar urgency into climate policy and accelerate the transition to a low-carbon economy. They could start by aligning stimulus measures with climate goals.”