By Nina Lagron, CFA, Head of Large Cap Equities, La Française AM.
ESG as alpha providers during crisis-ridden environments.
ESG stands for Environmental, Social, and Governance. Investors are increasingly applying these non-financial factors as part of their analysis process to identify material risks and growth opportunities. The SRAS-CoV2 crisis is the ultimate Litmus test for companies whose managements have integrated ESG factors. These so-called extra-financial factors are actually at the heart of the strategies of many corporates. Any organization taking a holistic approach to value creation is already on a long transformational road making it more flexible. It is hence more apt to absorb short-term shocks. Thus, any black swans can be weathered much better given already integrated flexible forward thinking. Corporates integrating ESG factors are more agile and light on their feet.
During the recent downturn of the equity market, strong ESG companies outperformed their peers during bearish as well as bullish markets. Admittedly, the time horizon is short, and we should be weary of generalizations. However, at year end, it will be interesting to reflect on 2020 performance.
One might imagine that mainly technical factors such as sector biases played a role in the pronounced outperformance since the beginning of 2020. However, even when neutralized for sector biases, high-scoring ESG corporates outperform within most sectors.
Regionally, the outperformance is more pronounced outside Europe, notably in the United States, where the inclusion of extra-financial factors is more recent and hence less mainstream. Differences in social and environmental regulations between Europe and the United States may lead as well to more noticeable differences between companies with above-average ESG standards.
During bearish markets, it was, in our view, mostly the strength in Social & Governance factors which led to this relative robustness: the strong management of Human Capital allowed for seamless employee protection and a reorganization process and in consequence minimized disruption. Investors felt that these companies could reopen more quickly than their peers.
Simultaneously, strong governance led to communicating transparently with investors and taking responsibility vis-à-vis their stakeholders. Investors were reassured and had greater visibility.
Many observers were surprised when high-scoring ESG companies outperformed their peer groups during the bull markets - especially as cyclical stocks outperformed defensive stocks.
At the trough of the market, a window of opportunity opened for ESG stocks and investors took advantage of the drop in share prices to redirect flows to ESG investments they might have missed, partly explaining the strength of the rebound thereafter. It might be utopic to believe that the world after the crisis will be radically greener than the world before. However, if a significant proportion of government stimulus is directed towards sustainable infrastructure and e-mobility it is plausible. The climate crisis has not been put on hold by the current pandemic. To the contrary, it is now considered to be an even greater threat to Humanity.
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