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The sell-off of shares at the start of 2020 saw a rapid withdrawal of money from investment funds globally but those investing in a sustainable way bucked that trend, according to new figures.
According to data provider Morningstar, cited in the Financial Times, some $373bn flowed out of mutual funds in the first quarter of last year but, within those figures, there was a $38.8bn rise in assets held in ESG funds - those investing according to an environmental, social and governance agenda.
The trend accelerated as the year went on and by the end of 2020 total assets held in sustainable funds hit $1.7trillion - a 50% rise on where they started the year.
ESG has been an increasing priority for individual investors but also for large institutional investors. The pandemic seems to have accelerated the move to ESG with greater importance being placed on companies being able to survive negative shocks and prove sustainable in the long term.
Undoubtedly the outperformance of ESG investments last year has helped. 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.
That initial analysis was expanded later in the year. 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.1
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 can suggest broad trends in markets but investors also need to bear in mind the circumstantial factors at play. The outperformance of ESG assets has coincided, for example, with a large downward rerating for oil stocks last year, which most ESG funds won’t hold. Oil and other energy stocks are among those ‘cyclical’ sectors which have suffered as demand in the global economy has been hit by the pandemic.
There is a question now about the performance of ESG if economic performance improves as nations begin to roll out vaccinations and emerge from lockdown. ESG funds have done well from the continued outperformance of high-quality companies - those whose shares are highly valued compared to their earnings, but whose earnings continue to grow steadily. If there is a sustained rotation towards less highly valued companies then the performance of ESG fund could be put under pressure.
Our Select 50 list of favourite funds includes a few which have an explicit focus on sustainability. Brown Advisory US Sustainable Growth offers a concentrated portfolio of American companies that are durable and grow at a sustainable rate. It differentiates itself to its peers by applying a valuation discipline that limits the fund from paying over the odds for businesses that fail to justify their price. In the view of our analysts, in periods of economic stress it will tend to offer defensiveness as its holdings are less tied to global economic factors.
The fund is one of Tom Stevenson’s five fund picks for 2021. Tom recently caught up with Brown Advisory’s David Powell, to find out more on how the fund is managed.
The Stewart Investors Asia Pacific Leaders Sustainability Fund, another of Tom’s fund picks for 2021, focuses on the high-growth potential of the Asia region, but has historically placed a high propriety on the sustainability of the companies it holds.
Find out more on Tom Stevenson’s fund picks for 2021
1 Fidelity International, 12 November 2020
Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. The Stewart Investors Asia Pacific Leaders Sustainability Fund invests in emerging markets which can be more volatile than more developed markets. The Brown Advisory US Sustainable Growth Fund and the Stewart Investors Asia Pacific Leaders Sustainability Fund invest in a relatively small number of companies and so may carry more risk than funds that are more diversified. The Stewart Investors Asia Pacific Leaders Sustainability Fund may use derivatives to reduce risk or to manage the Fund more efficiently. Select 50 is not a personal recommendation to buy or sell a fund. 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.
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