IF COMPANIES with strong environmental, social and governance (ESG) performance cannot protect you from a stock market rout, what good are they?
Leading ESG indices have mostly tracked their vanilla benchmarks over the past two weeks as global equities took a hit amid fears of a US recession. Among Straits Times Index (STI) component stocks, better ESG performance did not appear to correlate with better performance over a comparable period.
However, this does not mean that ESG investments are not worth their while. A single, short-term market correction on its own is not a good-enough foundation on which to build an investment thesis. If investors believe that structural ESG-related risks will continue to increase, the recent sell-off could be an opportunity to pick up ESG value.
Major stock markets around the world plunged on Aug 5, triggered by weak US jobs data, disappointing earnings from Big Tech and another round of rate hikes by the Bank of Japan. The MSCI All-Country World Index (ACWI) fell 3.2 per cent that day. In Singapore, the STI shed 4.1 per cent.
Amid the sell-off, the ESG editions of key equity indices had mixed results versus their parent benchmarks. In the two weeks from Jul 29 to Aug 9, the ACWI ESG Leaders index lost 2.4 per cent, slightly underperforming the ACWI, which lost 2.1 per cent.
Yet, in the region, it was the ESG benchmark that fared better. The ACWI Asia-Pacific ex-Japan ESG Leaders index gave up 0.7 per cent over the same period, better than the 1.6 per cent dropped by the ACWI Asia Pacific ex-Japan index. Singapore’s iEdge SG ESG Leaders Index retreated 5.2 per cent, modestly better than the STI’s 5.3 per cent decline.
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Outcomes were similarly mixed at the level of individual stocks. For instance, among the three Singapore banks – DBS, OCBC and UOB – OCBC’s 3.7 per cent decline over the period was about half that of DBS and UOB. However, OCBC received the lowest ESG scores among the three from Sustainalytics and S&P Global. There is, likewise, little correlation between ESG performance and share price movement among the real estate investment trusts in the STI.
A few observations are worth pointing out.
First, the ESG indices’ movements during the volatile two-week period quite closely tracked their vanilla counterparts. This is partly because there is significant overlap between the top ESG performers and the top companies in a particular market or sector. That overlap exists partly because larger companies tend to have more resources to spend on improving their ESG performance.
This raises the question of whether it is even necessary to use ESG indices to capture ESG performance. Perhaps simply buying a market’s prime large-cap index will give a good-enough approximation of that market’s ESG leaders. But the recent correction is not a good basis for drawing that conclusion, and that is because of the second observation, which is about timing.
It is important to note that these observations focus on a two-week window. While ESG risks and opportunities can certainly manifest in the short term, their costs and benefits are typically more appropriately assessed over longer-term periods.
For example, the impact of climate change on sea levels is difficult to notice over the short term. That is why long-term institutional investors like GIC are still convinced that a phenomenon like climate change will create long-term structural changes that need to be planned for. Any performance gap between a vanilla basket of stocks and one with only the best ESG performers might require a longer timeframe to be properly ascertained.
The third observation is that ESG risk is just a subset of the many dangers and uncertainties faced by a company. ESG is not a material factor in every market correction. The recent sell-off was sparked by worries about a US recession, which makes the economic and financial aspects of a business more directly relevant than ESG performance.
ESG investors should therefore not get overly spooked or excited about short-term performance of their portfolios. It may be more useful to assess short-term market movements, like what we saw at the start of the month, as opportunities to buy or sell at favourable prices.
This story first appeared in ESG Insights, a weekly BT newsletter. Readers can sign up for it at https://www.businesstimes.com.sg/newsletter/esg
