Investments in ESG strategies in the main were excellent in 2020. There were a number of conditions thought that made ESG look good. I would happily wager that these returns easily influenced and turned a few heads which would have inspired many investment pounds to be diverted towards the style. These returns most definitely created a great deal of column inches that claimed the investment style to be the future of investing, but how much thought was actually given to why and how these returns were achieved?
Before I go any further, I want it to be known that unless we collectively do something positive about redressing the imbalance and about the environment, or climate change then what is the point of saving for the future or making profits as future generations will not be able to enjoy it. Doing whatever we can as an investment community to promote the health of the planet cannot be a bad thing and therefore it shouldn’t be chastised – even though there is a great deal of greenwashing out there which makes it understandable that many are annoyed – me included. But, to quote Tesco “every little helps” and we all do need to do our bit to help out, so surely investing in ESG funds is a good thing.
But, back to the header of this piece, and to answer the question, I do think that 2020 was a great year due to investment headwinds and tailwinds, not necessarily great stock picking. My arguments are thus:
- Covid 19 forced economies to rapidly shutdown. Global GDP contracted incredibly quickly. As we all know, traditional supply and demand economics tells us that prices rise as demand outpaces supply, and prices fall as supply exceeds demand. Oil keeps the wheels of commerce moving (in more ways than one) and a high oil price generally acts as a tax on global economies. In 2020, as global GDP contracted, the price of oil fell (and due to an unusual contango event, even went negative at one stage in the year). When oil prices fall, the share prices of oil companies generally follow – they are likely to earn less money and have lower profits.
- Oil is not exactly front of mind in an ESG investors handbook or investment universe. Just avoiding oil stocks, when their share prices are falling will relatively make an ESG portfolio look good.
- In the midst of uncertainty last year, banks all over the world were informed by their regulators to suspend dividends to help shore up their balance sheets in anticipation of a huge wave of defaults. Banks are very much aligned to the strength of the economy and generally see their profits rise as economies grow and interest rates are both positive and rising. Along with huge amounts of stimulus from governments, central banks cut (already low) interest rates – thus putting greater pressure on profits. In a world where dividends are important (how many times have we read the headlines “the hunt for yield?”) and banks are not allowed to pay dividends, it’s not surprising to see the shares of bank stocks fall in 2020.
- ESG investors generally are not big friends of banks and financials either due to a number of factors, but when you consider what a bank does (i.e. it lends to companies and individuals at levels higher than the cost of capital) and take it one stage further (i.e. they charge higher rates to the less privileged; they refuse services to those lower down the earnings spectrum; they have loaned to businesses that are not ESG friendly – think arms, coal, oil etc) and you can see why banks are not on the nice list.
There are many other examples but being “underweight” or nil weighted to banks and oil stocks in a year when the share prices of oil stocks and banks underperformed certainly puts you into a positive light. Financials and oils account for a very large proportion of many stock market indices.
So, ESG did well through not having exposure to the headwinds caused by covid-19.
What about the tailwinds? Not wanting to get into the arguments surrounding the taxonomies relating to ESG and the issues put forward by many around greenwashing and being quite “top level” about it, for a moment, please consider technology. As a broad industry classification, tech (and US tech in particular) had an absolutely stunning year in terms of returns and many ESG funds had a high allocation to tech. There are many positives suggesting tech is good from an ESG perspective – for instance, just think how many Zoom calls have been had over the past year and how many there will be when the world opens up again which will massively cut the need for business travel? How would the world have fared without the internet? If we’d have suffered Covid-04 rather than Covid-19, I do wonder if we’d be in a different situation.
Even though there were some issues in the immediate shutting down of economies and the associated supply problems with toilet rolls, paracetamol, flour and pasta for instance, the world moved online, and Amazon was a major beneficiary. Tech winning again. Even though restaurants couldn’t open, the delivery services were winners (tech again) and so on. Many more examples can be given, but I think you get my point.
Think also about the shift (that has, in reality been going on for a few years) the last year has seen with regard to electric vehicles, and Tesla in particular. Tesla saw its share price rise manifold in the year, and electrification of transport is considered very much ESG friendly.
The global economy had shrunk, the growth sectors were tech (in the main) and investors happily paid up for them.
The investment universe of ESG won last year, because of both headwinds and tailwinds. The main headwind stocks were not in the investment universe, the main tailwind stocks were. It could be considered the perfect conditions, and in reality, did ESG managers really need to do much to outperform? I would argue that 2021 will be a bit different.