Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

In many fields - politics, economics, health - 2020 will be a year that is examined and analysed for years to come.

In terms of the stock market, that analysis has already begun and one theme that jumps out is the resilience of companies which score well on ESG (Environmental, Social and Governance) grounds.

After the initial drop in markets in February and March, Fidelity examined company performance during the period and found that companies with high sustainability ratings performed better than their peers as markets fell. This supported the theory that companies with good sustainability characteristics have more prudent management and will demonstrate greater resilience in a crisis.

Now, that initial analysis has been expanded to cover the months since then. It found that the strong positive correlation between a company’s relative market performance and its ESG rating held firm across the longer nine-month time frame.

In total, 2,659 companies covered by Fidelity’s equity analysts, and 1,450 in fixed income, were rated using Fidelity International’s proprietary ESG rating system. The system applies five ratings to companies, A to E, with an A rating being the best. The companies at the top of our ESG rating scale (A and B) outperformed those with weaker ratings (D and E) in every month from January to September, apart from April. Over the nine months, the A-rated stocks outperformed the MSCI AC World.

Taking a closer look at performance, the groups with higher ratings fell less as the markets collapsed and rose less when they recovered sharply in April than those with lower ESG ratings. This suggests that those stocks with higher ESG ratings are less prone to volatility in the broader market.

Analysis like this should be the start of a discussion about ESG and performance, rather than the end, and there are many important caveats to this work. In particular, we should bear in mind that the crash in markets this year had one very specific cause - the pandemic - which has limited certain types of activity far more than others. Airlines, for example, have been hammered due to lockdown restrictions preventing us from flying, but airlines are unlikely to be hit as hard in a different type of market crash - one caused by a crisis in the financial system, for instance. In that example, it would be partly coincidence that a company which scored poorly for ESG also performed badly in a stock market crash.

Another feature of stock markets this year has been the outperformance of high-quality ‘growth’ stocks versus more cyclical, value stocks. Could it be that companies rating more highly on ESG factors just happen to fall into the first category, explaining their better performance?

The Fidelity analysis attempts to account for this by grouping companies in categories based on their quality growth characteristics, by looking at the return on equity each company generated. It found that within each grouping of similar quality companies, a higher ESG rating still correlated with better performance.

We should expect more analysis like this as the growth in ESG investing continues. It adds to the evidence that sustainability is not simply a question of morals, but of hard-nosed financial interests as well. Earlier this week, the pension company Scottish Widows confirmed it is to divest £440m from companies scoring badly for ESG. It is likely that more large investors will see sense in backing sustainable companies for financial, as well as ethical, reasons.

Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. An Investment Manager’s focus on securities of companies which maintain strong environmental, social and governance (“ESG”) credentials may result in a return that at times compares unfavourably to similar products without such focus. No representation nor warranty is made with respect to the fairness, accuracy or completeness of such credentials. The status of a security’s ESG credentials can change over time. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

Topics covered:

ESG investments; Markets; Volatility

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