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June 25, 2020 | GSAM Connect

The Great ESG Reset

The events of the last few months have challenged how economies function, households consume, and businesses operate. COVID-19 is the type of event that accelerates change. We expect capital markets will allocate capital toward the businesses that are positioned to benefit in the new landscape. Environmental, Social, and Governance (ESG) practices are at the forefront of this landscape.

For ESG investing, the “E” has come into focus given the consequences of climate change that are already present. The “G” is almost a given as shareholders clearly expect effective governance of their companies. Today, there is an increased focus on “S” as social issues have been brought to the forefront during the pandemic. Businesses that within their financials means focus on long term security among employees, communities, and customers may find much greater resiliency in weathering the current climate than companies who are not best in class in these areas. We expect more proactive commitments to ESG best practices among leaning companies

From a portfolio point of view, we have found that investment managers who use ESG factors in their investing process have outperformed their broader peer set historically (Exhibit 1). Active ESG funds are both overrepresented in the top quartile of active US large cap funds in Morningstar and underrepresented in the bottom quartile of that universe, suggesting that there may be a potential benefit to incorporating ESG factors in the investment process.

EXHIBIT 1: ESG Investors Have Historically Outperformed

Source: Morningstar and GSAM Strategic Advisory Solutions. As of May 31, 2020. The analysis is based on oldest share classes of the roughly 1,000 US domiciled US Large cap funds in Large Blend, Large Growth, and Large Value Morningstar categories and the funds are quartiled based on performance. Past performance does not guarantee future 

 

The most recent downturn has stress tested corporate resiliency. Performance has suggested the market recognizes that companies with best in class ESG practices may create competitive advantages even during volatile times. For example, the ESG industry leaders that JUST Capital has identified prioritize the needs of all their stakeholders (including workers, customers, communities, and shareholders) and have seen their shares outperform in the crisis1. In our view, investors should not be concerned that companies getting involved in economic and social issues are distracting from their core business operations or hurting their profitability. In fact, they should demand it because impactful corporate action is core to their resiliency.

We believe it is important for investors to use ESG metrics with material financial bearing. Factors such as equal pay initiatives, a living wage, apprenticeship programs, and board diversity can be helpful signals in assessing effective management. If a company scores strongly on these metrics, we believe they are likely to have more satisfied, more productive employees, which can play a role in higher equity returns (Exhibit 2).

EXHIBIT 2: Equity Returns Can Be Linked to Employee Satisfaction

Source: Glassdoor, Thinknum Alternative Data, and GSAM Quantitative Investment Strategies. As of December 31, 2019. Past performance does not guarantee future results, which may vary.

 

The recent COVID-19 crisis has tested the resiliency of corporations and in our view will likely reshape their roles in the world going forward. In a recent survey by JUST Capital, 89% of Americans polled agreed that this is an opportunity for large companies to hit “reset” and focus on doing right by their workers, customers, community, and environment2. ESG factors, especially social ones, may help investors identify the beneficiaries of such a great reset in the economy. 

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About the Author

Candice Tse

Candice Tse

Managing Director, US Head of Market Strategy, GSAM Strategic Advisory Solutions

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