by Detlef Glow.
Looking back on the year 2020, it can be said that no investor has seen such a year before, even if one looks back to the Great Depression or World Wars I and II. The year started off with fears about a possible war between North Korea and the U.S., an upcoming trade war between the U.S. and China, and a possible hard Brexit. In a normal year, these geopolitical tensions would have put enough pressure on the markets to cause a major downturn. But in mid-February the coronavirus, which has been seen as a local problem in China before, was detected in more and more countries around the world and finally caused the COVID-19 pandemic.
Governments around the globe closed their borders, economies, and societies to prevent the spread of the virus. These lockdowns led to a major downturn in the equity markets in March and an additional sell-off in other liquid assets as investors wanted to protect their money. Within these market conditions, the price for oil went below zero for the first time in history.
That said, the governments did not only introduce lockdowns, they also released fiscal stimulus packages to support companies and residents and to cushion the expected economic downturn. In addition to these relief packages, central banks around the globe restarted or increased their quantitative easing programs to keep the liquidity in the markets up. Altogether, the amounts that have been spent for all the relief packages from the different institutions globally reached a level that has never been seen before.
As a result, the securities markets returned in general to a normal pattern, while equity markets around the globe rallied and hit new all-time highs.
All-in-all, 2020 can be considered as a year in which active asset managers had the chance to deliver a high value added compared to passive strategies since they can use cash as a risk buffer in times of market turmoil and may invest in high beta stocks in an upswing of the market. Generally speaking, active fund managers of equities funds did not deliver on this target during the market downturn in the first quarter of 2020, as 55.40% of the funds were underperforming their technical market indicator. Nevertheless, we witnessed a higher resilience against losses for funds which followed an ESG-related investment strategy during this time period. Please read the study: Are ESG Funds Outperformers During the Corona Crisis? for more detailed information about this.
To cross check these findings, we did a second analysis at the end of 2020 where we calculated the relative performance of all actively managed equity funds (primary share classes) globally versus their technical market indicators. In sum, this comparison showed somewhat better results for ESG-related funds than their conventional peers as their overall average outperformance was 3.31% compared to 1.19% for conventional funds. Overall, though, the general percentage of funds that outperformed their technical indicator was higher for ESG-related funds (59.15%) compared to conventional funds (49.52%). That said, ESG-related funds showed an on average higher underperformance (-8.66%) compared to their conventional peers (8.24%).
With regard to these results, one could conclude that ESG-related funds may have a better resilience during rough market periods and can deliver a higher outperformance compared to conventional funds. Even as I generally agree with this statement, one needs to bear in mind that some of the conventional funds have been massively impacted by negative oil prices, while ESG-related funds would normally not invest in fossil fuels. Additionally, the general trend toward growth stocks from the new economy might have also favored ESG-related strategies since a number of these stocks are also the favorites of ESG investors because these companies do often show a better ESG performance than industrials or other companies from the old economy. Therefore, one needs to attribute at least some parts of the superior performance of ESG-related funds to the market circumstances. In other words, once investors start to favor value stocks, which are often found in sectors which are known for their high consumption of fossil energies, the performance pendulum may swing back to none-ESG-related funds.
As resilience against market downturns is one of the key drivers for the success of an investment strategy, it is still not clear if ESG-related strategies are superior compared to conventional investment strategies. That said, it has been proven that some measures on the governance of companies can reduce the overall risk of defaults in a portfolio. But these measures are not exclusively used in ESG-related strategies.
From my point of view, the Achilles heel of risk management in all kinds of strategies can be seen in the measurement of risk. The majority of asset managers measure the risk of their portfolios relative to their benchmark or index, which means they will evaluate a negative performance as a success as long as the negative returns are better than those of the respective index or benchmark. Conversely, most investors see negative returns in general as bad results. Therefore, it would make sense that asset managers would implement some risk measures with regards to the absolute performance of their funds to align the interest of investors with the targets of the portfolio managers. Taking the absolute performance into consideration would also help to increase the resilience of a fund, since the portfolio manager could use cash as a risk buffer. I certainly know that this is a topic that is widely discussed and there are several different views on this topic in the investment industry. Therefore, I will leave this to another discussion.
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