Bear markets historically have not been good to sustainability investors. The most obvious example is the fate of cleantech in two previous market crashes. In 2000, when the dot-com bubble went bust, cleantech stocks collapsed. They recovered, however, and equity valuations rode a financing surge from both private equity investors and public markets through the mid-2000s. But when the financial crisis struck in 2007, many cleantech stocks were left in the dust as investors fled capital-intensive and early-stage industries. For skeptics, the collapse of cleantech affirmed a gross but common over-generalization about sustainable stocks – that they are a kind of bull-market luxury.
Pivot to today, and investors are navigating a social, health and economic crisis whose impact might well make us all revise our notions of what a “Great Recession” is. If the putative rules some might have learned from the collapse of cleantech still applied, then sustainable equities should have taken an outsized hit even as the market crashed. Valuations should have been all the more fragile given the rise in green investment in the few years leading into 2020. And the recent outright collapse of traditional energy prices should have sounded the death knell for sustainable stocks – it almost certainly would have a decade ago.
Yet this time around, none of that has happened.
In fact, sustainable equities – which today comprise a far broader and less-capital-intensive set of industries and companies than can be captured by the notion of “cleantech” – have generally outperformed the major indices so far this year. For example, funds based on so-called environmental, social and governance principles – ESG for short – have enjoyed better relative performance, on average, than wider benchmarks. In March, according to separate analyses by Morningstar and Bloomberg, respectively, about 60% of ESG-focused large-cap equity funds and ETFs outperformed the S&P 500. And Bank of America Merrill Lynch research has found that during the sharpest period of index decline, between Feb. 19 and March 25, stocks in the top quintile of ESG metrics beat the S&P 500 by five percentage points.
Granted, ESG metrics include governance and social responsibility scores, which might or might not be directly linked to the imperatives of environmental sustainability. Sustainable funds that take a more focused thematic approach, however, have also proven resilient in the COVID-19 environment. In our own experience, we have found that our long-term strategy of allocating assets according to four main themes – energy and power technologies, water/wastewater solutions, waste management and pollution control, and health and well-being – has proven extremely resilient compared to the MSCI World Index through the pandemic panic.
In short, there has been no evidence of green flight.
No doubt, one reason might be the increasing popularity of ESG in recent years, especially among institutional investors. As well, ESG principles tend to identify companies with better risk mitigation and management practices, and so are better equipped to withstand a crisis. Investors have begun to see sustainability themes as opportunities, and most sustainable funds use some form of ESG criteria these days. Fans of the ESG movement have long argued that it produces lower-risk, lower-beta, higher-performing investments; the current crisis might well prove them right.
Another factor is that the scope of “sustainability” has widened. As the themes in our strategy suggest, sustainable opportunities are not just in battery packs and solar panels anymore, but cut across a broad range of sectors. While there is a high capital intensity to the energy transition required to address climate change, many other themes in sustainability can be less capital-intensive, helping to insulate them from market shocks. And with greater breadth in opportunities comes less correlation to traditional energy prices – a dynamic that overwhelmed the themes in prior recessions.
Some firms, obviously, have fared better than others in the current climate, including specific health and well-being stocks that provide measurement and testing solutions to the healthcare and scientific sectors. Companies developing renewable power projects, meanwhile, have tended to retain guidance in this downturn given the long-term nature of their contracts and ongoing commitment from companies and governments to embrace less polluting energy. There are also opportunities in water treatment for firms to take over underfunded water systems from local governments especially given the strain near term on tax revenues.
Sustainability stocks in other segments, especially those more exposed to the economic cycle, have not fared as well. Yet the robust relative performance of sustainable equities during a crisis is no longer in question. The better question might be what happens once the world returns to some semblance of normalcy?
In our view, the resilience of sustainable equities isn’t just a one-off generated by a few outperformers, but rather illustrates secular trends. The rise of ESG is one; the diversification of sustainability is another. Yet more generally, the current pandemic might accelerate an evolved view of capitalism, one where there is more acceptance of government intervention (of which there has been quite a lot lately, of both the regulatory and the fiscal variety) and corporate responsibility towards employees. When this is over, will the body politic more readily recognize that markets are imperfect at directing capital towards the areas of the most pressing social and environmental need? Will people, business and markets more readily accept government action in these areas through incentives and regulation?
We think it’s possible and indicative of the recent pledges by U.S. Business Roundtable towards more of a stakeholder focus. Of course, investors are understandably wary whenever someone says, “It’s different this time.” But when it comes to sustainable investing, the world has changed. And although it comes at a heavy price, the coronavirus pandemic might be the catalyst to make it change for good.