Top ESG equities show their resilience in 2021
Coming out of a volatile 2020, the sharp rise in inflation and the potential for rising rates were two of the key market drivers during 2021 – and certainly have been for the beginning of 2022. This backdrop does not look set to alter dramatically, at least in the near term.
What also looks set to potentially endure for longer, even when the environment changes, is investors’ appetite for investing responsibly. Environmental, social and governance (ESG)-focused strategies appear to be taking an increasingly large share of investment flows - a trend we believe will continue.
During 2020 - one of the most tumultuous periods in recent memory - sustainability-focused portfolios enjoyed record sales, a trend which spilled into 2021. According to Refinitiv Lipper data, last year a record $649bn flowed into ESG-focused strategies globally - a significant uplift on the $542bn and $285bn of inflows witnessed during 2020 and 2019 respectively.1
It seems investors, from institutional to retail, want to know their cash is having a positive impact; that their investments are being put into companies which are not negatively affecting the environment, employees or communities.
At AXA IM our twin aim is to make a positive impact on society and deliver sustainable long-term investment returns. Our own research suggests ESG screening can deliver a premium - our 2020 analysis found that excluding stocks with poor ESG factors delivered a better performance than the benchmark index, and this is something which was repeated last year.
We outline below how we found that ESG-focused investors, on average, potentially fared better in 2021.
Robust standards potentially mitigate downside risk
We believe it is essential to assess how ESG factors could affect a business and its potential future profitability. As such, a key part of responsible investing is avoiding stocks with high ESG-related risks. This means examining how a firm’s operations affect the environment and how it is potentially exposed to climate-related risk – which could put the company at risk from regulatory decisions, supply chain disruptions and more.
At AXA IM, most of our assets under management are put through a screening system – our Sectorial Exclusions - where we remove companies that fall into certain categories. These include climate risk, controversial weapons, deforestation and ecosystem protection as well as soft commodities, where short-term financial instruments may drive price inflation in produce such as wheat and soy.
- How 2021 became the year of ESG investing (trust.org) As at end of November 2021
In addition, many of our strategies also apply our ESG Standards Policy, which contain additional exclusions based on companies with severe controversies, exposure to white phosphorous, tobacco and low ESG quality.
We believe that by excluding stocks based on ESG factors, investors can potentially enjoy better and more sustainable returns. For this analysis, we took the MSCI All Country World Index (ACWI) and excluded stocks which would be removed according to AXA IM’s Sectorial and ESG Standards policies, on a market capitalisation-weighted basis. This meant jettisoning 4.1% of the MSCI ACWI from our universe.2
Over 2021, the index delivered a total return of 18.54%, however with our exclusions in place - Sectoral Exclusions and ESG Standards - the aggregate return was a superior 19.1%, showing an uplift of 0.57 percentage points (ppts).3
Notably, our ESG Standards exclusions achieved an excess return of 0.62 ppts versus the MSCI ACWI for the 12-month period, although the Sectoral exclusions detracted 0.09 ppts.
While this data relates to performance in 2021, history shows markets can and will fluctuate over time, sometimes dramatically so. However, the excess performance of the universe after exclusions, compared to the benchmark, reinforces our view that applying ESG and Responsible Investing screening to our portfolios does not necessarily impact the ability to outperform the broad market, while also adding potential downside risk protection against ESG related tail risks.
A 2021 ESG premium?
Diving deeper into the data we used an ESG scoring methodology to evaluate the ESG performance of companies globally, giving them a score between zero and 10.
Using the same MSCI ACWI benchmark, with an equal-weighted weighting scheme, we split the universe into the industry sectors created by MSCI and Standard & Poor’s, known as the Global Industry Classification Standard (GICS). Within those sectors, we separated companies into quartiles by market capitalisation. To avoid double counting the impact of dual listings on the returns, secondary listings were excluded from the analysis.
The ESG scores, which are regionally adjusted by design, were subsequently ranked by quartiles within these intersections to neutralise sector and size biases, with the first quartile being the highest ESG scoring names. We rebalanced on a monthly basis.
- AXA IM altered its ESG scoring methodology in October 2021
- All performance data: FactSet, MSCI as at end of December 2021 (Net Returns US dollars)
The analysis shows that companies with high ESG scores fared better than those with inferior scores, delivering an excess return of 5.4 ppts.
The fourth quartile underperformed the overall universe by 3%, while the top quartile outperformed by 2.6%. Notably, the performance pick-up over the last two months of the year can be attributed to the top quartile’s exposure to low volatility names; high volatility was one of the poorest performing global factors in 2021. High ESG names also saw returns contribution from the ‘Quality’ factor.
Tackling global challenges while creating value
In what was another year clouded by uncertainty, which witnessed rising inflation and the persistence of the global coronavirus pandemic, AXA IM’s exclusion policies managed to add 0.55 ppts to the benchmark return. Most notably, low-volatility, higher-ranking names in ESG terms, achieved outperformance versus lower ranking ESG names.
And while past performance should never be viewed as a guide to future returns, this analysis has however bolstered our conviction that good ESG scores can be seen as an indicator of both quality and stability.
Ultimately, we continue to believe that rigorous ESG investment analysis has the potential to not only help deliver a more sustainable future – for both the planet and the global economy – but also more sustainable long-term returns.