Despite Skeptics, Sustainable Investing Holds Firm for Green COVID-19 Recovery

In past years, sustainable investing strategies have tempted investors with the promise of doing something good for the world, rather than gaining direct financial reward. Now the global COVID-19 crisis has put sustainable funds to the acid test, and some leading analysts see strong signs that the financial merits of sustainable investing are holding true, despite red flags raised by skeptics.

A ringing bottom line endorsement for sustainable funds

Several analysts began to see signs of strength in sustainability investing quite early in the COVID-19 crisis. Despite the COVID-19 storm gathering overseas in January, first-quarter 2020 flows in the U.S. set a new record of $10.5 billion in positive territory for sustainable investing, far outpacing the same quarter last year.

As global markets spiraled downhill in March, Morgan Stanley and other analysts took note that funds using environmental, social and governance (ESG) screens suffered less damage than conventional funds. More recently, on September 17, Morgan Stanley followed up with a new report that comes down firmly on the side of sustainable funds and their performance.

The firm’s analysis of U.S. equity and bond funds from January to June 2020 reached the strong conclusion that “sustainable investing does not require a financial trade-off.” During this period of global economic meltdown, Morgan Stanley found that taxable sustainable bond funds “outperformed their traditional peers by a median of 2.3 percent.” Sustainable equity funds fared even better, hitting a mark of 3.9 percent over conventional funds.

On September 21, the firm also issued a new sustainability commitment of its own: to achieve net-zero financed emissions by 2050. In announcing the commitment, the firm stated that it “joins many of its clients in this strategic goal and is committed to providing financing, expertise and thought leadership to support the transition to a low-carbon world.” Morgan Stanley plans to focus on standardization and methodology for carbon reporting in order to achieve its 2050 goal while also assisting its clients.

Red flag No. 1: U.S. investors are lagging far behind their European counterparts on sustainable investing

Another perspective on sustainability investment comes in a new report by Morningstar. Like Morgan Stanley, Morningstar took note of the ability of sustainable funds to weather the downturn sparked by the COVID-19 crisis.

Morningstar looked at second-quarter results for 2020 and noted that global inflows into sustainable funds rose by 72 percent in the second quarter to reach $71.1 billion. That brought the total to a record of almost $1.1 trillion by the end of June. The firm credits that performance to the second-quarter stock market recovery combined with “growing investor interest in environmental, social, and governance issues.”

Unfortunately, investor interest in the U.S. has been running far behind the activity within the E.U. “Europe continued to dominate the space, garnering 86 percent of the global inflows, while the United States took in 14.6 percent,” Morningstar analysts noted.

With a leadership gap like that, it is small consolation that many other parts of the world are falling even farther behind the Morningstar analysis.

How U.S. investors can pick up the pace on COVID-19 recovery

Part of the problem with the slower growth of sustainable investing in the U.S. may be traced to uncertainty over federal climate policy. While the European Union has shown strong signs of rallying around a green COVID-19 recovery, Republican policymakers in the White House and the U.S. Senate have blocked proposals to unite the nation — and its investors — in a similar endeavor.

Nevertheless, Morningstar did take note of one powerful trend that could attract more investors to U.S. sustainability funds. Over the past three years, hundreds of conventional funds in Europe have been rebranded as sustainable to reflect new sustainability commitments or upgrades to existing sustainable investing strategies.

In a parallel trend, asset managers are beginning to rebrand their products, too.

Red flag No. 2: What’s really behind the relative strength of sustainable funds?

As with sustainable funds rebranding, the asset manager trend is also much stronger in Europe than in the U.S. However, if interest in sustainable investing continues to grow, rebranding could help reassure U.S. investors that sustainable funds are firmly grounded in long-term, bottom-line principles that have succeeded for many years under different names.

However, with skeptics continuing to raise questions about the performance of sustainable funds, the lack of a supportive federal framework could continue to tamp down investor demand in the U.S.

In August, for example, economists based at the New York University Stern School of Business published a study that questioned the data behind ESG fund performance during the COVID-19 crisis. They proposed that other factors could explain the relative strength of sustainable funds.

“Industry affiliation, market-based measures of risk, and accounting-based variables that capture the firm’s financial flexibility (liquidity and leverage) and their investments in internally-developed intangible assets together dominate the explanatory power of the COVID returns models,” they explained.

On the other hand, the research team based its study on a comparison with data from the global financial crisis of 2008-2009. That was barely more than 10 years ago, but in that short period of time, the fields of renewable energy, energy storage, electric mobility and other sustainability systems have skyrocketed from R&D backwaters to mainstream commercialization.

Without fully accounting for the technology transformation, comparing 2020 to the economic crisis of 10 years ago does not appear to offer particularly strong support for the skeptics’ case. Instead, the comparison serves to demonstrate what could have happened to sustainable funding without a decade of innovation and investors’ support.

U.S. business leaders push for more sustainable investing

As a further demonstration of investor support for new technology — and in the absence of a strong federal policy supporting sustainable investing during the Donald Trump administration — hundreds of U.S. business leaders have united to draw attention to the prospects for profit under decarbonization.

One breakthrough moment for private sector sustainability leadership occurred in May, when the U.S.-based We Mean Business coalition of 155 global corporations joined the U.N. Global Compact in support of the Science-Based Targets Initiative.

Last week, We Mean Business took stock of recent major developments in corporate sustainability, including new commitments from Best Buy, McKinstry [note: not to be confused with McKinsey], Real Betis, Schneider Electric, and Siemens in support of The Climate Pledge initiative for net zero by 2040, co-founded by Amazon and Global Optimism.

Another leading U.S.-based group, America’s Climate Pledge, also released a new sustainability progress report, arguing the U.S. has already reached a renewable energy “tipping point,” thanks in part to corporate leadership.

The report notes that this “bottom-up” leadership on climate action has been a key factor driving U.S. progress on decarbonization even after President Trump started the process of pulling the U.S. out of the Paris Agreement on climate change.

However, the report also argues that supportive federal policy will be a necessary element to accelerate change.

U.S. voters have the power to remove federal policy obstacles this year. Early voting has already begun in advance of the November 3 election cycle, and the result will determine who holds the office of the U.S. president, along with several key Senate seats.

With the impacts of climate change already in full evidence, millions of U.S. investors, large and small, will also have an opportunity to exercise their voice at the ballot box and demonstrate their support for sustainability funds through the levers of the democratic process.

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