How Do ESG Funds Perform in Volatile Markets?
Introduction
Environmental, Social, and Governance (ESG) funds are a type of investment that considers non-financial factors such as a company’s environmental impact, social responsibility, and governance practices. ESG investing is based on the idea that these factors can have a significant impact on a company’s long-term performance and financial success.
In recent years, there has been increasing recognition of the importance of considering ESG factors in investment decisions. Many investors are looking for ways to align their financial goals with their values, and ESG funds provide a way to invest in companies that prioritize environmental and social responsibility.
There is also growing evidence that ESG funds can perform well in volatile markets. In fact, net flows into ESG funds available to U.S. investors totaled $20.6 billion in 2019, nearly four times the previous annual record [1].
This suggests that investors see potential for these types of investments to provide strong returns, even in times of market uncertainty.
The performance of ESG funds in recent volatile markets
There have been several examples of ESG funds outperforming the market during times of volatility. For example, the MSCI USA ESG Select Index, which tracks companies with strong ESG performance, returned 16.5% in 2020, while the S&P 500 index returned 16.3% [1].
Similarly, in the midst of the European debt crisis in 2011, the MSCI Europe ESG Index outperformed the MSCI Europe Index by over 5 percentage points [1].
There is also data on the overall performance of ESG funds compared to traditional funds during periods of market turmoil. In a study conducted by the Institute for Sustainable Investing, ESG-focused mutual and exchange-traded funds (ETFs) had similar returns to traditional counterparts from 2004 to 2018, but with lower downside deviation, indicating that ESG funds may be less risky in volatile markets [1].
Other studies have found that ESG funds may have slightly lower returns than traditional funds in some cases, but with higher Sharpe ratios, indicating a higher risk-adjusted return [2].
It is important to note that the performance of individual ESG funds may vary and it is important to carefully research and consider all investment options before making a decision. Additionally, investors should be aware of the potential for higher fees with some ESG funds, as the average expense ratio for ESG mutual funds was 0.79% in 2019, compared to 0.53% for traditional mutual funds [2].
However, some research has found that top-performing ESG funds may have a higher weighting in companies with strong ESG scores, which could potentially lead to better returns [3].
The reasons for the strong performance of ESG funds in volatile markets
There are several reasons why ESG funds may have strong performance in volatile markets. One reason is that environmental, social, and governance (ESG) factors can play a role in reducing risk in a portfolio. For instance, companies with strong ESG practices may be better equipped to handle regulatory changes, supply chain disruptions, and other potential risks.
In this way, ESG considerations can help to mitigate risk and improve the stability of an investment.
Another reason for the strong performance of ESG funds in volatile markets is that ESG companies may be more resilient in the face of economic downturns. For example, companies with strong environmental practices may be better able to adapt to changing market conditions, such as shifts in consumer preferences or new regulations.
Similarly, companies with strong social responsibility practices may be better able to maintain customer loyalty and a positive reputation during times of crisis.
Finally, there is increasing demand for sustainable investing options, which can lead to more stable investments. As more investors seek out opportunities to align their values with their financial goals, there is likely to be continued growth in the ESG market. This increased demand can provide a stable foundation for ESG investments, even in times of market volatility.
Overall, the strong performance of ESG funds in volatile markets can be attributed to a combination of risk-reducing ESG factors, the resilience of ESG companies, and the growing demand for sustainable investing options.
