RI funds resilient in downturn, outperform in recovery

By Fundata Analytics

August 17, 2020

There is a growing disconnect between stock markets and the economy, and investors are taking notice. We are now going through what is being called the worst economic downturn since the Great Depression, but the major North American indexes are almost back to their pre-COVID all-time highs. The Nasdaq Composite Index has actually exceeded the high it set back in February, and the S&P 500 Composite Index is down only 1.5% from its all-time high. Toronto’s S&P/TSX Composite Index is down 8% from the high it set in February, although the it had a bigger drawdown to recover from.

Most of what is driving stocks seems to be the massive injection of government and central bank stimulus over the past few months, but we won’t really know how effective it will be or for how long it will last for quite some time. Investor confidence is still not great. At the time of writing in mid-August, the 10-year U.S. Treasury yield was a rock-bottom 0.666% (a very scary level), down 58% from where it was before the pandemic triggered the major risk-off sentiment that led to the March market meltdown. Gold hit an all-time high on Aug. 6 at over US$2,000/oz. but backtracked somewhat in subsequent days.

So where do investors turn when they are tentative about stocks but don’t want to miss out on potential gains? A good place to start researching fund investments is in the responsible or sustainable investment sector. These are investment funds whose mandate stipulates that environmental, social, and governance (ESG) factors play a central role in the investment selection process.

The theory behind ESG screening is that companies that measure well in the ESG factors are well positioned not only for long term growth, but also have built-in resilience to market downturns. In fact, this resilience was demonstrated during the market crash from Feb. 19 to March 23. The accompanying graph summarizes the average performance in three major equity categories and compares the responsible investments (RI) to the regular equity funds (Non-RI).

As can be seen, Canadian Equity RI funds lost 36.5% compared with the non-RI funds, which lost 36.6%, so there’s no real difference there. This is likely due to the fact that in terms of portfolio holdings, the difference between the RI funds and the non-RI funds in the Canadian Equity space is minimal; they hold many of the same stocks.

Both the RI and the non-RI funds lost less than the S&P/TSX Composite, which was down 37.4%. The two best performers in the Canadian Equity RI universe were the Desjardins SocieTerra Canadian Equity Fund, which limited losses to 33.7%, and the IA Clarington Inhance Canadian Equity SRI Class, which lost 34.0%.

The U.S. Equity RI funds dropped 27.2% compared with the regular funds, which fell 29.5% and the S&P 500, which slid 33.9%. Again, Desjardins delivered with an exchange-traded fund that performed best in this segment. The Desjardins RI USA – Low CO2 Index ETF (TSX: DRMU) limited losses to 24.8%. The Desjardins SocieTerra American Equity Fund was almost as impressive losing just 25.1%.

Global Equity funds tell a similar story. The RI funds lost 26% compared with the non-RI funds, which fell 27.8%. The CI MSCI World ESG Impact Fund was the best in this group, dropping 17.1% in the period, while the Desjardins SocieTerra Positive Change Fund was next with a 20.7% loss.

All this talk of “losses” still doesn’t sound great, but if you look at the performance over the past year, you start to see the real benefits of the sustainable approach, especially in the Global Equity and U.S. Equity categories. Global Equity RI funds have returned 13.8% over the past year to July 31, compared with the category average of 2.3%. The U.S. Equity RI funds have a 1-year return of 13.4% compared with the category average of 5.5%.

During the historically long bull run leading up the COVID-19 pandemic, it was hard to differentiate between strategies because everything was doing well. Now that we have seen some adversity, it is easier to see which strategies have been the most beneficial over the longer term. Incorporating ESG factors into the investment process is one of those strategies.