How will ESG investing weather a recession?

A cross section of industry commentators give their views

The wealth manager’s view

Max Richardson, senior director, wealth planning, Investec Wealth & Investment

Research on the performance of companies that manage ESG risks during recessions is limited, but the available studies suggest mixed results. Some studies have found that highly rated ESG stocks tend to outperform traditional stocks during economic downturns, while others have found no significant difference in performance between the two groups.

One study by MSCI, a leading provider of ESG data, found that ESG stocks outperformed traditional ones during the 2008 financial crisis, with a lower decline in stock prices and a faster recovery.

On the other hand, a study by the London School of Economics found that ESG stocks performed no better or worse than traditional stocks during the 2008 crisis. The impact of the crisis on ESG stocks was revealed to be largely dependent on the specific industries and companies, rather than their ESG status.

So, the jury is out on how companies that manage ESG risks will fare in a recession, but the data doesn’t indicate that investing in such companies in an economic downturn will harm relative returns.

As wealth managers, it is our fiduciary duty to account for fundamental risks when investing our clients’ assets and many ESG risks are fundamental risks. With the luxury of investing over long-time horizons, integrating ESG risks forms a key aspect of our mission to achieve superior risk-adjusted returns over the entire economic cycle, not just in periods of recession.

The fund manager’s view

Isabella Hervey-Bathurst, portfolio manager, Schroders

Our Global Climate Change Fund focuses specifically on companies that will benefit from the effort to address climate change, rather than on ESG more broadly. History is never a perfect guide to how a theme will perform in a recession, but it is striking just how much has changed for climate technologies and policy since 2008.

Electric vehicles are no longer a niche industry, renewables are now the cheapest form of energy in much of the world after massive cost declines (having been highly dependent on subsidies, some of which were withdrawn as the last recession began to bite), and corporate and political will behind the energy transition has surged. Indeed, more than 90% of global GDP is now covered by a net-zero target, and decarbonisation plans are embedded into many corporate strategies.

The crucial trends for climate change investors are on a much firmer footing than they were in 2008.

Turning to recent events, while a recession clearly carries risks, we are more positive on the theme than we were a year ago.

Valuations have compressed to more reasonable levels as investor exuberance for climate tech has waned, and the cost inflation and supply chain disruption that impacted the profitability of many industrials is easing.

The US Inflation Reduction Act and Europe’s response to the Ukraine war have also increased the support for the energy transition, and therefore for the companies geared to the theme. Despite the near-term risks, the long-term structural story is in very good shape.

The analyst’s view

Laura Hoy, ESG analyst, Hargreaves Lansdown

Responsible investment isn’t necessarily about narrowing your investment horizons to renewable energy companies and electric vehicle makers. In its simplest form, it can just mean considering ESG issues when you invest.

Recession fears are grabbing headlines right now, but ESG-focused investors are playing a long game. A growing consensus about the dangers of climate change and other environmental issues is driving significant policy changes.

Social issues have spun into massive global movements, leaving a trail of battered and bruised businesses in their wake. And there’s no need to outline how important company oversight is when it comes to surviving the test of time.

While a global recession will certainly muddy the waters in the near term, there’s no question that the trends ESG investors are tracking hold long-term potential.

It’s impossible to trim emissions or shift company culture overnight, and ESG investors are betting on that fact. As budgets thin, the companies that have already made necessary changes to improve their ESG credentials will find it easier to stay the course.

ESG investors who’ve been tracking these risks in tandem with their investment strategy can capitalise on this. Companies willing to abandon these long-term strategic initiatives in favour of hiding in ‘survival mode’ are short-sighted.

Given the push for energy independence that’s running parallel to the looming recession, there are some trends that could put sustainability focused investors in a strong position.

Companies working to find cheaper alternative energy sources and those offering solutions that allow us to do more with less could be following in the footsteps of some of tech’s heavy hitters like Netflix, which hit its stride by introducing online streaming during the financial crisis.

The fund buyer’s view

Amanda Sillars, fund manager and ESG director, Jupiter

As fund buyers on behalf of investors within the £7bn Jupiter Merlin range of multi-asset portfolios, we believe the likely performance of ESG in a recession will depend largely on the wider interpretation of what ‘ESG’ really means.

Funds that exclude entire sectors on ESG grounds – most usually oil, gas, miners, defence and so on – run the risk of delivering weak absolute performance should these sectors outperform. This was the case in 2022, when energy was the only global equity sector to deliver positive returns, rising by nearly 50%.

This subset of ESG strategies inevitably tend to have a structural bias towards expensive growth and technology stocks as they often attract a high ESG score. This was a winning strategy for the decade prior to 2022, when equity markets were led by these characteristics. However, with the dramatic rise in inflation globally last year, the share price of these companies fell – precipitously, in some cases.

By contrast, fund managers who retain a broad investment universe and select companies that generate strong cashflows, minimal debt and are valued cheaply, while keeping company engagement at the heart of their investment strategy, are likely to fare better during a recession. As a result, company management will be encouraged and empowered to accelerate their ESG journey.

This is particularly true if interest rates are elevated making the cost of servicing debt high, as is the case currently. The similarity we draw is with homeowners, who need higher reserves and cashflow to pay higher mortgage costs.

This is one of the many reasons why we, as fund buyers, favour active fund managers who execute their onerous ESG responsibilities via engagement as opposed to exclusion.

This article first appeared in the February issue of ESG Clarity’s sister title Portfolio Adviser.