Dr. Svetlana Borovkova: ESG and coronavirus crisis - What can we learn?

Dr. Svetlana Borovkova: ESG and coronavirus crisis - What can we learn?

Svetlana Borovkova

By Dr. Svetlana Borovkova, Probability & Partners

In my last column, I showed that investors do not have to sacrifice financial performance when investing in more sustainable firms, i.e., those scoring higher on Environmental, Social and Governance (ESG) metrics. So how did such firms perform during the recent period of coronavirus-related stock market turmoil?

A recent report by Morningstar claimed that higher scoring ESG firms have shown more resilience during the COVID-19 crisis. On the other hand, some academic studies (such as that by professor Philip Joos of Tilburg University) have refuted such claims. Coincidentally, Ying Wu -also at Probability & Partners- and I have investigated a large set (1.100) of US and EU stocks: the results turn out to be more subtle.

First, the resilience of higher scoring ESG stocks varies greatly per sector of economy. For example, utilities, materials and energy companies with high ESG scores have indeed proved more resilient than their less sustainable counterparts.

Second, there are significant differences between US and EU firms: for US firms, the resilience of higher scoring ESG firms is indeed greater, while in the EU, such firms performed on par with lower ESG scoring firms.

The third takeaway of our investigation – and perhaps the most significant one – is that the different components of E, S and G performance play different roles in crisis resilience, especially for different sectors. Overall, we find that the G (governance) score is the most important determinant of resilience in a global crisis such as this one. Well-governed firms (i.e., those with a high G score) are better able to manage opportunities and risks in this crisis, by responding effectively to the recent supply and demand shocks. This is observed across all sectors: the losses of higher G-scoring firms in the period January – May 2020 are practically zero, compared to average 15% losses for the others. The sector where the effect of G score is the greatest is Health Care (which is definitely in the spotlight during the coronavirus pandemic). Well-governed healthcare firms are more likely to meet the enormous demand for medical products and are seen as more capable of developing vaccines and treatments for COVID-19. 

In sectors such as Energy and Utilities, it turns out that the E score (Environmental) separates crisis-resilient firms from less resilient ones. In those sectors, firms that score highly on Environmental, have suffered on average 6% lower losses than other firms. It seems that, when fossil fuel industries are heavily hit by the plunging demand for oil, more sustainable energy and utility companies hold up better due to their diversified energy sources and higher exposure to alternative energy. 

Finally, we see that sustainable firms are more stable and less volatile than other firms in this stress period. In general, they are hit less and rebound less, in both the US and EU. 

Overall, we believe that especially in times of crisis, investors should take sustainability into consideration when they choose companies to invest in. High ESG scores are not a panacea against crisis-related losses, and subtle differences between various sustainability aspects and different sectors should be taken into account. However, we see that there is a lower risk in the performance of sustainable companies, and this is vital during a stress period. 

Probability & Partners is a Risk Advisory Firm offering integrated risk management and quantitative modelling solutions to the financial sector and data-driven companies.