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How COVID-19 Is Affecting ESG Investments?

Corporations have always been expected to prioritize the welfare and best interests of shareholders, so while there has been talk of a movement toward social and environmental commitments, there wasn’t a lot of action among investors or issuers toward ESG business models.

The COVID-19 pandemic has dramatically changed the corporate landscape. Let’s take a closer look at how ESG investments have outperformed during the COVID-19 pandemic and what the future holds.

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ESG Outperforms During the Crisis

The COVID-19 pandemic has led to an outperformance of companies operating under ESG best practices. The employees at these companies already had paid sick leave, health insurance benefits and flexible work arrangements that simplified the transition and reduced the impact on revenue and profitability.

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There’s evidence that these best practices have paid off:

  • HBS Professor George Serafeim found that companies with ESG-like employee and supply chain practices outperformed industry peers between February 12 and March 24, 2020.
  • Bloomberg and Morningstar confirmed these findings by showing that ESG fund returns exceeded non-ESG funds.
  • MSCI found that bond issuers with higher and improving ESG ratings outperformed competitors during the first quarter.

In addition to an easier transition to the “new normal”, ESG-focused companies have faced less criticism from consumers—particularly after they accepted public funds. The public image of ESG-focused companies tends to be better than competitors, which could lead to a more resilient business long-term.

Shake Shack Inc.’s (SHAK) decision to return its government PPP loan after finding $10 million in the credit markets is a solid example.

Some ESG Concerns

The outperformance of ESG-focused stocks has driven up valuations over the years. While investors may still invest in ESG-focused companies despite higher operating costs, research has shown that ESG characteristics tend to be inversely correlated with expected returns given the ESG premium.

There’s also some debate about what exactly constitutes an ESG investment. MIT’s Aggregate Confusion Project found a very low correlation between ESG ratings from top ratings agencies, underscoring the difficulty of evaluating ESG factors.

The COVID-19 pandemic has also had an uneven impact on ESG-focused companies. In healthcare, socially responsible hospitals and medical offices have closed for routine business and doctors’ revenue fell 50% to 90% in some cases. These dynamics could lead to consolidation in the market.

Despite these higher operating costs and other concerns, it’s difficult to quantify the impact on investors. ESG-focused companies may have more productive employees and less turnover. These could contribute to faster revenue growth and less hiring or training costs relative to non-ESG companies.

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Impact on Mutual Fund Investors

Investors continue to prefer ESG-focused companies and there’s little sign that these trends will stop. While short-term profits may be negatively impacted, the long-term outlook appears more promising and many investors care about more than absolute returns in their portfolios.

The COVID-19 crisis has already led to a significant inflow into ESG funds as investors shift their priorities.

Source: CNBC

Investors should carefully consider the criteria used to judge the ESG attributes of a portfolio before committing any capital. With the wide array of definitions, everyone has a different idea of what it means to be ESG-focused. You should find the ideals that most closely match your investment goals.

Don’t forget to check out ESG-focused mutual funds here.

The Bottom Line

COVID-19 has led investors to reevaluate their shareholder-centric view of a corporation’s purpose to be inclusive of environmental, social and governance goals. While there may be a short-term performance penalty, many investors are starting to look beyond absolute returns when building their portfolios.

ESG mutual funds are an easy way to align your investment holdings with your moral objectives and potentially realize higher long-term returns due to improved brand reputation and greater resilience during crises like the current pandemic.

Be sure to check our News section to keep track of the latest updates from the mutual fund industry.

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Jul 01, 2020