Why ESG funds have seen stickier assets and outperformance in covid-19 crash

Investment commentators are unsurprised to see some of the best responsible investment funds retained assets during the recent global sell-off

ESG investment commentators have said they are unsurprised to see that top-rated responsible investment funds retained more assets during the recent global sell-off, and were also among the best performers.

Data compiled by Last Word Research found that European-domiciled funds with a Morningstar Sustainability rating of ‘High’ saw inflows of €1.1bn in the first quarter of 2020 – a period that saw a significant uplift in volatility levels as a result of the coronavirus pandemic, causing investors to retreat from stock markets.

Funds with a Sustainable rating of ‘Above Average’ also saw flows of €1.3bn, and similarly in Q4 of 2019, another period of uncertainty for investors amid the delayed UK exit from the European Union, funds rated ‘High’ saw inflows of €4.4bn and funds rated ‘Above Average’ received €4.6bn of flows.

In comparison funds rated ‘Low’ or ‘Below Average’ saw outflows of €1.5bn and €2.3bn respectively in Q1 2020, and outflows of €3.3bn and €4.8bn in Q4 2019.

This is amid a backdrop where all European long-term open-end funds and ETFs took in €42.8bn in the Q1, a dramatic drop from the €104.1bn of inflows seen in Q4 2019.

Patrick Thomas, head of ESG investing at Canaccord Genuity Wealth Management (CGWM) and ESG Clarity editorial panellist, said: Money is flowing out of traditional funds and into ESG funds during the worst crash since 2008. And it is becoming apparent that investment behaviour is not going to revert.”

Dan Kemp (pictured), CIO for EMEA at Morningstar Investment Management and ESG Clarity editorial panellist said he was not surprised by the flow data or that many ESG funds outperformed non-ESG funds.

“In previous, downturns, particularly in the tech crash, we saw ethical funds hit hard due to their high exposure to areas that sunk such as technology and smaller companies.

“In the recent downturn, we are seeing something completely different with low or non-ESG companies are being hit much harder.

“For example, returns of our ESG portfolios have fared better than our conventional portfolios, even though they have the same research, asset allocation and the same team behind them.”

Reinforcing the point on flows being stronger in ESG funds, FE fundinfo has released a list of funds attracting the most money in the Investment Association’s UK All Companies sector over the past month with a number of responsibly-invested funds in the top 124 funds that saw flows throughout March.

Royal London’s Sustainable Leaders Trust saw inflows of approximately £91.4m over the month, while Liontrust’s UK Ethical and Sustainable Future UK Growth funds saw flows of £26m and £21.3m respectively.

The other responsible investment funds to see inflows were (in descending order of flows): Kames Ethical Equity, L&G Ethical Trust, Investec UK Sustainable Equity, Edentree Amity UK, Scottish Widows Environmental Investor, L&G Future World ESG UK Index Fund, Castlefield B.E.S.T Sustainable UK Opportunities, Schroder Responsible Value UK Equity, Threadneedle UK Sustainable Equity, and the L&G Future World Gender in Leadership UK Index Fund.

Fund performance

CGWM’s Thomas carried out his own analysis of the ESG fund performance, looking at 203 ESG open-end and ETFs available in the US as rated by Morningstar.

He found that ESG portfolios are outfperforming throughout the stockmarket crashes where global indices were dropping 20% in a week.

 “Looking a month back from 12 March, you see the returns of 66% of ESG funds ranked in the top halves of their respective Morningstar categories. More than a third (39%) ranked in their category’s best quartile, while only 11% ranked in their category’s worst quartile. 

“Broadening the perspective to year-to-date, the relative outperformance of ESG funds is even better. The returns of 69% of ESG funds ranked in the top halves of their respective categories. The returns of 42% ranked in their category’s top quartile, while only 12% landed in their category’s worst quartile.”

He found similar results in passive funds; when comparing 26 ESG index funds with their respective conventional funds, he found that 24 outperformed over the month-long period and all 26 outperformed year-to-date. Looking regionally this was more pronounced in Europe and EM than in the US, he said.

“We don’t think we have seen the bottom yet – and no-one knows how the covid-19 story will end  but if you needed more proof that ESG is way more than just a passing fad, it seems that in the chaos of the last few weeks where markets have back flipped, tumbled, soared back and dropped off again, ESG fund performance is coming out better that its compadres,” Thomas stated.

Damien Lardoux, head of impact investing at EQ Investors, also said he was unsurprised by the movements and highlighted the global equity funds featured in the EQ Positive Impact Portfolios “strongly outperformed” the MSCI World Index in March and year-to-date.

“This is a lot down to sectorial positioning where they tend to overweight healthcare the best performing sector and had zero exposure to energy, the worst performing sector.

“But what’s really interesting in this downturn is that while those funds tend to have a mid-cap bias, and despite small and mid-caps indices underperforming large caps, sustainable funds have been able to materially outperform larger cap indices.”

He added this isn’t something that has been seen in other crises, especially “not too this magnitude of outperformance in such a short time frame”.

“I think we are going to see number of mainstream investment managers now looking at adding sustainable funds to their portfolios. At long last, sustainable and impact investing becomes common sense investing,” he commented.

However, Morningstar’s Kemp cautioned that while it was encouraging to see ESG funds retaining assets and seeing inflows in difficult times, he highlighted there is a concern the outperformance could attract the wrong type of investor.

“I hope the recent outperformance doesn’t do anything at all for ESG investing.

“I hope people are choosing ESG portfolios as they want to align investors with their values rather than chasing performance.

“There is a danger this could attract investors who primarily interested in the returns, not the underlying investments,” he said.


Natalie Kenway

Natalie is editor in chief at MA Financial covering ESG Clarity, Portfolio Adviser and International Adviser. She was previously global head of ESG insight for ESG Clarity and has been an investment journalist...