The financial market’s free-fall amid the early stages of the global coronavirus pandemic was far-reaching and relentless.

Many assets tumbled as COVID-19 cases and death rates rose through late February and March and into April, with stocks and high-yield bonds bearing the brunt of the damage. However, that damage also spread to traditional safe havens such as US Treasuries and gold, which experienced volatile swings as the bad news unfolded.

The treacherous conditions also extended to the realm of sustainable finance. This means that environmental, social, and governance (ESG) investing is experiencing its first true market test, having only entered the mainstream over the past half-dozen years or so, during a historic bull market.

In the wake of the fall, outlooks for all asset classes have remained muddy at best, subject to the scope and duration of the recession that could stem from millions of consumers being rendered jobless and home-bound, sapping both demand and the ability to pay for goods and services.

ESG Approaches Weather the Initial Storm

ESG investing endured 2020’s first-quarter downturn relatively well: Bloomberg reported that 59% of US ESG-tied exchange-traded funds (ETFs) outperformed the S&P 500 Index between the start of the year and March 31. In addition, ESG ETFs took on $6.7 billion in new funds. Morningstar research conducted at the market’s nadir in March echoed Bloomberg‘s findings, concluding that losses in sustainable mutual funds and ETFs were relatively smaller than declines in their conventional counterparts.

Admittedly, a portion of the relative outperformance may be tied to an aversion to oil and gas companies, which suffered as oil prices dropped as much as 66% during the first quarter in the biggest falloff since the height of the Great Recession. Fueling the collapse was a deterioration in demand combined with surging supply stemming from a Russia–Saudi Arabia price war, and the fundamentals contributed to a more than 50% plunge in the S&P 500 Index’s energy sector since January. That said, some suggest that fossil fuel exclusions alone cannot sufficiently account for the performance differential.

Still, the MIT Technology Review noted that capital woes in the energy sector could be problematic for renewable energy projects, especially when oil is historically cheap and economic slowdowns disrupt global supply chains. However, others argue that the current public health crisis could fuel urgency around climate change because the consequences of this global pandemic are likely miniscule compared to the forthcoming effects of climate change.

An Early Test of ESG Commitments

Beyond the market-level data, the pullback also served as a gut check for companies that had attained notable levels of ESG achievement.

Reassuringly, many companies that adhere to stakeholder capitalism‘s focus on employee, customer, and community benefit tapped business crisis management responses that encompassed social impacts of their business. For example:

• Verizon Communications, a component of both the MSCI USA ESG Leaders Index and the MSCI USD IG ESG Leaders Corporate Bond Index, expanded services and waived fees for most subscribers and prioritized first responders’ communication needs.
• Dialysis provider DaVita, a 2019 Dow Jones Sustainability Index component, announced it was collaborating with Fresenius Medical Care North America and other competitors to protect patients from spreading or being exposed to the coronavirus while receiving dialysis.
• Manufacturing conglomerate 3M, a component of the MSCI USA ESG Select Index, rapidly expanded production of N95 respirator masks by tapping surge capacity previously built into its operations following the SARS epidemic of 2002-2003.
• Childcare provider Bright Horizons, a component of the MSCI USA Small Cap ESG Leaders Index, offered free childcare to first responders in centers designed to handle COVID-19.

Challenges Still Forthcoming

While these kinds of short-term actions are fulfilling ESG-related aspirations, the true test of any organization’s commitment to ESG principles and sustainable business practices looms in the coming quarters. As the pandemic’s economic impact takes hold worldwide, some companies will endure, but others will struggle, potentially diminishing ESG priorities.

As Generation Investment Management co-founder Colin le Duc explained to ImpactAlpha in March, the pandemic strengthens the case for long-term thinking and resiliency, given the fragility of conditions as they stand today. Yet corporate convictions will be tested.

“I think the truth will be revealed as the tide has gone out,” he said. “There’s an authenticity advantage to people who are committed and that’ll play through, at the company level as well.”

For those who subscribe to the tenets of ESG investing, the performance and efforts of high-quality, sustainability-minded companies in the coming 12 to 18 months will be just as telling as 2020’s first quarter in validating the underlying philosophy.

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