A Year in Review - 2020

  • A Breakout Year

A bumper year for Environmental Social Governance based firms and instruments in 2020 has been viewed by many as indicative of a breakout event for a trend which is set to continue into 2021 and beyond. With some of the year’s top performing funds, such as Ballie Gifford’s Positive Change Fund, returning over 80% in the last year, and Bloomberg reporting that inflows into ESG Exchange Traded Funds (ETF’s) topped $22bn, a three-fold increase on the previous year, many are backing further gains in the coming years. Behind this, they cite a genuine and permanent shift in the interest investors take in the responsibility shown by the companies they choose to finance. Below, we delve into the drivers behind this performance, and whether this trend is a statement of intent regarding what is to come.

  • Investors Awoken

ESG Investing is related to the consciousness of investors when making investment decisions. Does this mean that investors “awoke” in 2020? This is a question we are left asking ourselves after seeing the substantial changes related to ESG investing.

It is undoubtable that ESG’s importance has grown significantly in the past years, whether it is through rising concerns over climate change, the lack of diversification among employees, the leadership of a company or pressure from shareholders. This growing importance is reflected in changes of the company's policies, its culture and in the decisions of investors.

Compared to previous years, ESG is now at the forefront of the minds of most senior executives. According to a 2018 global survey by FTSE Russel, more than half of global asset owners were already implementing or evaluating ESG factors in their investment strategy, indicating a surge in popularity was imminent, it was just a matter of when. Moreover, the compliance to these standards is supervised and monitored in some firms, making its use compulsory.

For example, Dutch pension fund ABP has been functioning with a program for full integration of ESG across all asset classes since 2015, based on their investment philosophy and responsibility accountancy. Another example is BlackRock’s recent engagement to put sustainability at the center of its investment strategy going forward, according to CEO Larry Fink’s annual letter to the chief executives. He finished its letter by stating “Climate Risk is investment risk”. This move by BlackRock, which is the world’s largest investment firm, is a sign of what could be expected for all other big firms if they decide to follow.

Looking back at 2020, it is possible that this change in investor sentiment has occurred and been amplified as they seek to have their values represented by the company they invest in, or those who invest on their behalf. They look to invest in companies creating and adding “real value” to the world. This can be due to COVID-19, seeing investors taking a step back to analyze their investments in companies from an ESG and long-term perspective. Therefore, companies are doing more in terms of ESG with the goal of improving their reputation and attractiveness, knowing it is not enough to be a reputable long-standing firm, and that they need to adapt to current market trends to attract investors.

  • The Everything Rally

The COVID-19 evolution had a huge impact on all assets from the period of February to March, when the lockdowns started being placed worldwide. We saw a collapse across asset prices. The Dow Jones for example, lost 36%, the S&P 33%, big falls that can be compared to 2008 Financial crisis. This can clearly be viewed as a golden opportunity for investors to come in. Moreover, with the advancement in technology, investing has become much more accessible resulting in a rise in retail investor activity. Many markets have now fully recovered, and in cases exceeded pre-COVID 19 levels, with many predicting them to rally further in the coming months.

Expansionary monetary and fiscal policies implemented, played a decisive role in this rally, spurring equities from March lows to record highs, as governments worldwide use these policies to stabilize economic activity and price developments in the on-going pandemic. Low interest rates have resulted in bonds being an unappealing prospect, as central banks keep prices high and yields low to allow governments to service record deficits. Indeed, the yield on 10Y Gilts in the UK for example, dropped to record lows, seeing investors turn to other assets in a hunt for yield, fueling the current rally and allowing firms to raise finance effectively in the equity markets to see them through the crisis.

There can be little doubt that the impact this had can also be felt in ESG holdings, and their significant weightings in growth stocks, which tend to perform best in low-rate environments.

  • Political Impact

With pledges worldwide for corporations and nations to be carbon neutral at some stage in the future, the UK’s ‘Net Zero’ target by 2050 a notable example, it is clear this is a trend which is here to stay. As a result, there will be a notable reliance on both current, and future companies within the green energy space to deliver progress to ensure that this happens.

In 2020, COVID-19 and the significant positive impact lockdown measures had on the environment, has brought this to the forefront of many investors and members of the population, who will no doubt be placing additional pressure on governments to deliver this agenda. This was no more apparent than Joe Biden’s electoral victory in the US, with a key pledge being to bring forward a plan to invest $2tn in sustainable energy, seeing investors rush into alternative energy funds in their droves as his victory became more likely, and the resulting in the anticipation that companies in this space will see their future cash flows increase. Pledges such as 500,000 new electric vehicle charging ports, incentives for their purchase, and with the industry forecast to be worth $11tn, characterize the buzz around ESG holdings this year.

The anticipation of such plans in 2020, seeing companies such as Tesla appreciate by over 800%, were certainly a factor which seen the sector perform so well, and will be sure to have a positive impact on it in 2021.

  • Regulatory Impact

Known as Sustainable Finance Disclosure Regulation (SDFR), firms are now having to show and display characteristics which are in line with those represented by ESG. The pressure arising from the new regulations and expectations forces firms to be more transparent in their organizational activities and their overall approach to ESG. As a result, in 2020, we have seen asset managers rush to increase the proportion of their sustainable holdings in a bid to conform to new regulations and avoid the scorn of their investors. This also supports a rationale for some of 2020’s outperformance, as investors ‘jumped before they were pushed’, driving up the prices of a select number of popular holdings.

Some however have urged caution, citing fears of a ‘green bubble’ as a result of fund managers attempts to boost their ESG ratings with a select number of companies. These ratings could be misleading as we have seen companies with high prices while being unprofitable.

  • Favorable Weightings

Some concerns lie in the fact that ESG holdings are heavily weighted in favor of growth stocks, many of which are in their infancy and currently are not profitable and are highly geared, or both. And while this presents its own set of risks if we were to see an environment in which interest rates were to rise and that debt was to become more expensive, 2020 was a year which saw growth perform extremely well, seeing a gain of 29% versus just .71% for value, as vast amounts of liquidity and low interest rates provided a favorable backdrop for such companies.

In the aforementioned Ballie Gifford Positive change fund for example, holdings such as Zoom and Tesla were strong performers that produced big gains for the fund, while other standouts such as Blackrock’s iShares ESG Aware fund had a 28% allocation to tech, it’s most heavily weighted sector. In turn, ESG performance this year was aided significantly by the so-called ‘work from home’ trade brought about by COVID-19, and the high returns of the companies which facilitated that. Whether this continues into 2021 remains to bs seen.

  • Momentum

Like the appreciation of many companies share prices in 2020, there is little doubt that the ‘FOMO’ effect, seen the ESG trend fueled to an even greater extent. In 2020, ESG investing was as popular as it has ever been according to google, while the share price of numerous companies, especially technology, in which top performing ESG products were heavily weighted, skyrocketed despite being unprofitable.

Like many trends, merely because investors are interested in companies and follow it on a momentum basis, does not necessarily suggest that it is something which is not sustainable or based on sound rationale. Other points should also suggest that the ESG trend is one of greater significance than other less informed trades across the market in 2020. However given the level of inflows into ESG, retail investor friendly, ETF’s in 2020, it would be foolish to deny that at least some of the investors placing their money in such funds were doing so on blind faith that the only way is up, fueling some of 2020’s performance.

  • Resilient in the face of adversity

2020 was a year which demonstrated a move away from the adage that firms with strong credentials regarding their ESG traits, would provide inferior returns. While previously, so-called ‘dirty’ companies in sectors such as Oil and Gas have proven strong and reliable investments, the past twelve months have been bruising. This is not to say of course that they will not prove so again, but the myth that because companies choose to align its morality with that of its investors, that their profits and returns they provide to investors should suffer, appears to have been dispelled.

Regarding why this may be the case, it could be hypothesised that investors viewed the COVID-19 pandemic as a turning point in many respects, and in turn sought to ‘future-proof’ their portfolios as a hedge against industries which may suffer as a result of a more permanent shift in the way we do business. This could result in, for example, banking on a lower demand for commodities such as oil in the future due to a shift towards sustainable resources, or a lower requirement for commercial real estate as companies take a view that flexible working may become more prevalent.

Thank you to Craig McAuley and Maximilian Morte Von Jacobs for your in-depth analysis!

32 views0 comments

Recent Posts

See All