ESG isn’t just about “doing the right thing” – it’s about building a business that operates sustainably. ESG programs help companies manage a variety of ESG risks improving resiliency in the long term. A recent analysis from investment research firm Morningstar finds evidence to back this perspective. Morningstar looked at historical economic crises and tested the performance of ESG portfolios against their peers in the face of economic headwinds. They discuss the results stating:
“Sustainalytics used Morningstar Direct’s scenario analysis tool to run a series of stress tests on ESG-constructed portfolios during three past crises: the 2007-09 subprime crisis, the 2010 Greek crisis, and the 2011 US debt ceiling crisis. In all regions and for all three scenarios, the lower ESG risk portfolios had better return performance. This is likely because the factors common to the lower ESG risk portfolios regarding volatility, financial health, valuation uncertainty, and economic moat generate downside protection under these more negative economic scenarios—suggesting that low ESG risk portfolios have a better ability to withstand financial crises.”
While we caution against trying to tie ESG to stock price, this analysis offers interesting findings. ESG might not reduce the cost of capital or lead to ESG alpha, but it does make sense that ESG risks – particularly governance-related risks – manifest in times of economic crises. Firms with less exposure to these risks – or that are better prepared to manage them – fare better in the long term. Morningstar’s findings do not extend to every sector or region, and studies like these should always be taken with a grain of salt and it is fair to question whether the ESG ratings are fit-for-purpose to begin with. However, the results are encouraging nonetheless and reflect benefits of ESG in building resilient businesses.
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