Rather than being a luxury or an optional extra, our analysis shows that a focus on sustainability would have helped relative performance during the recent market turbulence.
Here at Schroders, our view of sustainable investing is that companies who treat their stakeholders fairly will see better share price performance than those who do not.
There had been increasing market debate on this topic before the Covid-19 crisis struck. Some took the view that sustainable investing was simply a luxury to be indulged in during a bull market, rather than a way to generate above-market returns throughout the market cycle.
Recent market volatility has offered an opportunity to test our theory of sustainable investing during a sharp market drop and a similarly swift rebound. The results are noteworthy.
Looking at European equities, our proprietary tool CONTEXT ranks companies according to their sustainability, as we explain below. Using these rankings, our analysis shows that European stocks ranking in the top quartile for sustainability experienced an average share price decline of 29% from the market peak on 17 February to the trough on 23 March.
By contrast, stocks in the fourth quartile (those considered the least sustainable) on average fell 38% in the same period. That compares to the benchmark fall of 35%.
Then, in the rebound that took place from 23 March to 17 April, top quartile stocks on average rose 19% versus 17% for bottom quartile stocks and 19% for the benchmark.
These time frames are obviously very short, and clearly past performance is never a guarantee of future returns. However, it is interesting to see that during the recent market turmoil – representing the height of market worries about the Covid-19 pandemic – stocks with a better sustainability profile saw better share price performance.
If sustainable investing has sometimes been perceived as a “luxury item” that investors could ignore in tougher economic times, this data suggests otherwise.
How are we measuring sustainability?
In the Schroders European Equities Blend team we use our proprietary tool, CONTEXT, to define the most and least sustainable companies.
This is a tool we developed in conjunction with our colleagues in the Sustainable Investment team.
CONTEXT enables us to analyse an individual company’s relationships with all its stakeholders. The stakeholders we look at are customers, employees, suppliers, regulators, shareholders, and the environment, as well as encompassing a company’s governance and management quality. The importance of each stakeholder differs by sector - regulators are a more important stakeholder for banks than they are for retailers, for example – and we take this into account.
Once we’ve assessed the strength of a company’s relationship with each of these stakeholders, we then compare that to other companies in the same sector. This results in a ranking by quartile for every company compared to its sector peers. It means that no quartile is dominated by any particular sector or investment style.
What are the post-crisis prospects for sustainable investing?
The severity of the Covid-19 crisis has shone a spotlight on the responses of governments, individuals, and corporates. Considerable media and consumer attention has focused on how companies are treating their stakeholders during this crisis.
For example, at the start of the outbreak, when lockdown guidance was less clear (in the UK at least), companies asking employees to work without personal protection, or where social distancing was impossible, faced a backlash from the press and the public.
Fair treatment of employees also extends to those temporarily unable to work as usual. Not every job can be done from home, and some employees will be home-schooling their children as well as trying to do their jobs. Flexibility from employers will be crucial in retaining a motivated workforce post-crisis.
Companies are offering support along the value chain too, to suppliers or dealers. Extending payment terms for rent, utilities or goods received is an example of this.
Positive headlines have been made by companies transforming their production lines to make hand sanitiser, protective gowns or ventilators, instead of their usual cosmetics, clothing or cars. Other companies have made donations to support medical research or local communities.
The above examples suggest that many companies across Europe are taking seriously their responsibilities towards their stakeholders. And their responses are being noted. A study on brand trust carried out in March by Edelman found 65% of people said their future purchasing decisions would be influenced by how companies behave during this pandemic. That figure rose to 88% in China. Companies who treat their stakeholders fairly now may find themselves better placed to face the post-crisis future.
The current crisis is having far-reaching impacts and we think corporate and consumer behaviour is likely to be permanently changed as a result. This crisis is different from previous ones in that government support is not just targeted at the financial system, but as a social grant to help companies and employees through this difficult period. This may in turn create a new and enduring social contract between governments, regulators and the workforce that perhaps wasn’t there last time round.