ESG factors weren't behind COVID-19 outperformance, study says

New academic research questions link between companies' high ESG scores and funds' outperformance

ESG factors weren't behind COVID-19 outperformance, study says

In the immediate aftermath of the first quarter’s COVID-19-induced downturn, many third-party investment data providers and fund managers saw a shining moment for ESG factors, which they linked to funds’ ability to outperform category peers on a risk-adjusted basis. But according to a new study, that thinking was off the mark.

The study, conducted by researchers from the University of Waterloo, Tilburg University in the Netherlands, and New York University’s Stern School of Business, questioned the idea that companies with high ESG scores were better-positioned during the pandemic, reported Institutional Investor.

In particular, the researchers noted reports by BlackRock, Morningstar, and MSCI, which all found ESG funds outperformed during the crash. BlackRock touted the better risk-adjusted returns exhibited by its sustainable funds during the first quarter, while Morningstar noted how 24 out of the 26 ESG-tilted index funds it tracked outdid their closest conventional counterparts.

But based on their own analysis, the proponents of the study found that first-quarter stock movements were more strongly correlated with leverage and cash positions of firms, along with specific industry sectors and market-based risk measures. Intangible assets, which some have argued are tough-to-measure drivers of value, were also positively associated with returns.

Extending their analysis to the 2008 financial crisis, they also found that liquidity and intangible assets were the best predictors of returns during crisis periods – not ESG factors.

“These results suggest that innovation-related assets rather that social capital investments offer the greater immunity to sudden, unanticipated market declines,” said the authors, who found that ESG scores “offer no such positive explanatory power for returns during Covid-19.”

The researchers noted how “widespread claims by fund managers, ESG data purveyors, and the financial press” led to perceptions of ESG as an “equity vaccine,” resulting in record inflows into sustainable funds during Q1 2020.

But looking beyond the initial crash in March, they found a negative association between ESG factors and returns during the second quarter. On the other hand, the evidence suggested that assets related to innovation continued to have a positive performance impact.

“Not only did more socially responsible firms not exhibit the alleged greater share price resilience during the highly unexpected Covid-induced market decline, but they actually performed significantly less well when the overall market recovered,” the researchers said.

While they expressed support for responsible corporate citizenship as a way to product longer-term shareholder value, they pointed to their results as “robust evidence that firms with higher ESG scores do not experience superior returns (i.e., smaller losses) during the pandemic-induced selloff in the first quarter of 2020.”


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