Lessons for investors from COVID-19Arian Neiron, Managing Director12 June 2020
Last month MSCI, one of the world’s largest index providers released a research paper, Five Lessons for Investors from the COVID-19 Crisis, which presents strong evidence to support ESG investing.
Cutting through MSCI’s thorough analysis, a summary of the five lessons are presented below followed by how we think you can put these findings into practice.
Lesson 1: Sustainable investing helped mitigate declines
COVID-19 has accelerated awareness of ESG factors. While the bushfires and drought forced focus on environmental considerations, the pandemic has raised awareness of social factors, including the responsibility of companies to minimise the impacts of the pandemic and to support the community during incredibly challenging times. Some companies too such as Gilead Sciences have worked for the public good by developing products to help stop the pandemic or treat the ill such as ventilators, vaccines and personal protective equipment.
What we now know is that doing good has helped some companies to perform better financially during this crisis.
MSCI examined the performance of six of its indices: four with explicit ESG objectives including socially responsible investing and ESG leaders; and two with explicit climate objectives, including low carbon target and climate change. As you can see below, during the first five months of 2020, all six indices outperformed the broader share market as measured by the MSCI World Index, with some of that outperformance attributed to ESG factors. The results are a compelling argument to include ESG investments in your portfolio.
Chart 1: Relative performance of selected MSCI Indices with ESG and climate objectives
Source: MSCI, as at 31 May 2020
Lesson 2: Managing factors was more critical than picking stocks
The coronavirus pandemic provided opportunities for generating alpha from active security selection and from managing factor exposure, according to MSCI. For example, factors such as momentum, size, profitability and ESG offered high positive excess returns, while other factors such as yield, leverage and long-term reversal suffered sharp declines during the COVID-19 crisis.
Chart 2: MSCI global equity model to 31 May 2020 factor returns
Source: MSCI, as at 31 May2020
Lesson 3: Indexed investing enhanced market efficiency
Investment strategies that aim to replicate indices generally remained resilient during the COVID-19 crisis and provided liquidity and flexibility to investors to effectively allocate assets, according to MSCI. While many exchange-traded funds (ETFs) experienced elevated trading volume, they continued to track their underlying indices closely, despite the jump in volatility. Tracking difference, a measure of how closely ETF net asset values (NAVs) follow their underlying indices, remained within the range observed during the more benign conditions of 2019.
Lesson 4: Rising volatility offered active investing opportunities
MSCI found that of the sample of active managed funds it examined, most underperformed during the first quarter as the COVID-19 crisis hit markets. Chart 2, taken from the paper, shows just 26% of actively managed funds outperformed their benchmarks in the first quarter of 2020 and that there is no evidence that high-conviction strategies, proxied by active risk, fared any better.
The market has rallied strongly since the first quarter of 2020 ended. When the June quarter ends, all eyes will be on research which analyses the returns of active managers compared to their benchmarks so investors can ascertain if they are proving their worth.
Chart 3: Q1 2020 Performance of active global equity funds, ranked by previous five year active risk
Source: MSCI, as at 31 March 2020
Lesson 5: Global investing provided diversification opportunities
Companies with assets and revenues across multiple geographies were more resilient during the COVID-19 crisis, a pattern evident over the longer term. Companies with international revenues in excess of 25% outperformed those with international revenues below this threshold in the first four months of 2020, MSCI found.
Chart 4: Internationally and domestically-oriented companies, relative to MSCI ACWI
Source: MSCI, as at 30 April 2020
Therefore, having a portfolio that includes domestic and offshore equities would have helped to minimise the impact of the COVID-19 sell-off. For Australian investors, the depreciation of the local currency also helped to cushion losses.
Putting it all into practice: ESG lessons for investors
These lessons from MSCI stress the importance of ESG, diversification and factor investing. And MSCI should know. The world’s leading index provider is also a leading global ESG researcher and has developed the world’s biggest range of ESG and quality indices.
MSCI offers indices that include negative screens for fossil fuels, socially irresponsible business activities and carbon emissions. The index provider has a team of over 190 analysts worldwide assessing companies in its global universe on a ‘AAA’ to ‘CCC’ scale according to their exposure to industry specific ESG risks and their ability to manage those risks relative to peers. MSCI is able to create indices that not only include negative screens, but also include highly ranked ESG companies. From this analysis, it develops its ESG indices, a sample of which outperformed during the pandemic, as detailed above. Investing in funds with both exclusions and inclusions is important.
But investors need to pick their ESG product very carefully. Transparency and ESG investing should go hand in hand.
MSCI’s research is now fully transparent. Investors can easily compare companies’ ESG ratings – useful tools for diligent investors keen to avoid corporate citizens who aren’t giving back to society, or even worse, destructing the environment or abolishing history.
You can, for example, look up individual company ratings, including that of ESG leader, Gilead Sciences, which has a AA rating from MSCI. The company has developed the only US -approved COVID-19 treatment, Remdesivir. One of the world’s biggest pharma companies AstraZeneca Plc now wants to buy Gilead1in what would be the biggest health-care deal on record. Not only is Gilead’s science advanced, but so is its ESG standing compared to laggards such as Facebook.
Gilead is a worthy component of any ESG fund. Facebook, whose executives are actively thwarting efforts to minimise misinformation and make the social media site less divisive, and Rio Tinto, who recently destroyed a 46,000 year old Aboriginal shelter, are not.
Yet Gilead is screened out of many sustainable funds due to overly simplistic security selection screens that rely on negative screening and do not include positive assessments, delivering sub-optimal ESG exposures. On the other hand, some purported ESG funds do include ESG laggard Facebook, despite its dismal record on protecting the privacy of its users’ data.
Investors need to do their research on the holdings of any ‘ESG’ fund to determine whether it is true to its label.
Another thing MSCI have done is allowed investors to compare funds. MSCI’s fund comparison tool can be found here - ESG fund ratings. It aggregates all of the holdings in each fund to give the fund an overall ESG rating.
As mentioned above a key to ESG investing is transparency. You should be able to look at the holdings of your ESG portfolio every day and be comfortable that the portfolio holdings are in line with your own values. ETFs are fully transparent investments and are therefore an ideally suited vehicle by which investors can build a diversified ESG portfolio.
The holdings of all VanEck’s ETFs are available on our website, including our ESG focused, VanEck Vectors MSCI International Sustainable Equity ETF (ESGI), which holds Gilead Sciences, and the VanEck Vectors MSCI Australian Sustainable Equity ETF (GRNV). In addition, we also make available a quarterly report to investors which outlines the carbon intensity and ESG exposure of these two portfolios here - ESGI and GRNV
In addition, both ESGI and GRNV track MSCI indices that screen for fossil fuels and social responsible investments combined with targeting ESG leaders. .
Melas, Dimitris, Roman Kouzmenko, Zoltan Nagy and Navneet Kumar, May 2020, Five Lessons for Investors from the COVID-19 Crisis; MSCI Research Insight
This information is issued by VanEck Investments Limited ABN 22 146 596 116 AFSL 416755 ('VanEck') as responsible entity and issuer of the VanEck Vectors MSCI International Sustainable Equity ETF and the VanEck Vectors MSCI International Sustainable Equity ETF ('the Funds'). This is general information only and not financial advice. It does not take into account any person's individual objectives, financial situation or needs. Before making an investment decision in relation to the Funds, you should read the relevant PDS and with the assistance of a financial adviser consider if it is appropriate for your circumstances. The PDS is available at www.vaneck.com.au or by calling 1300 68 38 37. The Funds are subject to investment risk, including possible loss of capital invested. The PDS details the key risks. Past performance is not a reliable indicator of future performance. No member of the VanEck group of companies gives any guarantee or assurance as to the repayment of capital, the payment of income, the performance, or any particular rate of return from a Fund. The Funds are indexed to a MSCI index. The Funds are not sponsored, endorsed, or promoted by MSCI, and MSCI bears no liability with respect to the Funds or the MSCI Index. The PDS contains a more detailed description of the limited relationship MSCI has with VanEck and the Funds.