It’s often been said that ESG investing is a means both to improve long-term performance and to mitigate risk. The market downturn and ongoing impacts of COVID-19 lockdown continue to test to that hypothesis, yet not all ESG managers have been created equal.

Jens Peers

Mirova US
What we are seeing now is that people are more aware of the fact that ESG strategies can actually generate good performance.

Some ESG funds have outperformed during Covid-19 lockdown. Do you think the current crisis will accelerate ESG trends in companies and the industry?

There are many ways to look at ESG and there are many methodologies too. So it's difficult to say whether a company is an ESG company or not, right?

But if you look at the big providers of ESG ratings, including MSCI, Sustainalytics and ISS, they all use the same data, but they all get to different conclusions. This makes it difficult to say if companies are really good ESG companies or not.

On average, the ones that score well on most of those methodologies have actually done very well during the Covid-19 crisis. That's also translated into the performance of many ESG-focused equity strategies like ourselves. Our performance was already very good going into the crisis, and it's been very good during the crisis too. And there are a few reasons for that.

First, by having a longer-term view, taking factors into account like governance and climate change, generally trying to avoid high environmental and social risks, you don’t tend to invest in some sectors that have significantly underperformed during the crisis, such as fossil fuels, aviation and tourism. Likewise, we don’t tend to invest too much in banks in general either, because many banks still cause systemic risks which may also affect long-term performance.

And we also aim to avoid those companies that take irresponsible risks with their balance sheet by taking on too much debt. On average, that means ESG managers do quite well during a crisis.

So will it lead to extra demand?

Yes, in a way it will because, until now, ESG investing was mainly considered by people that genuinely cared about the world. The people that are ok with the world or just focusing on performance in their portfolio said, ok, fine, but you cannot be good for the world and create performance at the same time. And, therefore, they said, I'm not going to invest in that way.

Increasingly, what we are seeing now is that people are more aware of the fact that ESG strategies can actually generate good performance. And for that to be accepted more broadly, you need more and better ESG managers.

Many of our competitors also have good performance, so there’s choice. And if you have a choice between two well-performing strategies and one has a good ESG profile and the other one does not, which one are you going to choose?

Well, many people now certainly go more for the one with a better ESG profile. So to cut a long story short, yes, I think that demand will certainly pick up from here.

We've also seen that, during the crisis, ESG strategies have actually seen inflows while the non ESG strategies on average have experienced outflows. At Mirova, we’ve had the same where, throughout the crisis, we've seen our assets increase against some of our competitors that don't take an ESG approach.

What’s going to drive performance going forward?

Well, if you look at the long-term potential recovery from here, I think it'll probably go in two phases. There’ll be a relief rally –and to a large extent, we've seen a bit of that already. Of course, there's a risk that some of those strategies underperform a little bit.

That relief rally is driven by those same sectors and stocks that underperformed the most during the crisis. It is possible for some of these strategies that they may not necessarily benefit in the early days of the recovery rally.

However, when things are normalised again after that, that's where the quality of your research will start to show again. I believe the long-term trends will pick up again, in terms of driving performance, and that's when things should really begin to normalise.

What might some of the winning investment themes look like in a post Covid-19 world?

It's the billion-dollar question, right? My view is that the world is still ageing, and we still have urbanisation and climate change –even though we've seen that the quality of the air and the CO2 emissions have actually been lower, because there's a lot less economic activity happening as well. But those long-term themes are still going to be very important.

There are a few things, however, that we believe will change. We think we're going to see an acceleration of the digitalization of our economy. Many people are now familiar with doing things like video conferencing, working from home and ordering things online. But in addition, businesses that have not actually been very active online, are starting to think about that a lot more too. It will certainly help a lot of the companies that we have in the portfolio with their businesses.

The second one that's very important is supply chain management. We've seen that Wuhan is probably the global production centre for many different industries, including many basic components for pharmaceuticals and the car manufacturing industry. Centralizing all your production centres into one specific city may actually lead to very important disruptions in your supply chain management, so it’s something that companies will have to start thinking about as well. Companies that have a wider distribution or sourcing network compared to others will continue to benefit.

Furthermore, globalization from an emerging markets point of view could be under some pressure. Poorer countries, as well as the bigger industrialized countries, are going to focus more on local production and local consumption, going forward.

Why do you think the Mirova Global Sustainable Equity Fund has proved so resilient during the Covid-19 pandemic crisis?

Because of the thematic choices that we make, the strategy has a few biases in terms of sectors and styles. From a style point of view, we have a small growth bias and a significant quality bias.

Indeed, one of the main reasons we’ve outperformed in the first quarter, during the Covid-19 crisis, is because we don't want to invest in companies that take irresponsible risks. We are significantly underweight in companies with high levels of debt, and in a crisis, those debt levels are obviously bad for performance.

Secondly, we have no classic energy or fossil fuels, which has been one of the worst performers, year to date, as well as during the crisis. The oil price war between Saudi Arabia and Russia has obviously pushed this sector down as well.

Another sector that was significantly hit was real estate. That's also a sector to which we have no exposure at this point. We're now looking at a few names because valuation opportunities are certainly there in that sector.

And we’ve been significantly underweight in financials. Financials have also been a very poor performer during the Covid-19 crisis. We also don’t have aviation, tourism or luxury goods in the portfolio, and those are all sectors that were very badly hit during the crisis too.

Which sectors have contributed positively for the strategy?

We’ve been a bit overexposed to IT. Tech companies have been reasonably good performers on average.

The biggest overweight position that we have is in healthcare, which has also contributed positively. Looking at companies in our top 10, the likes of Danaher and ThermoFisher have testing equipment, including testing for Covid-19. We have Gilead in the portfolio as well, which was the first company that had a drug against Covid-19 in phase three trial, and it has been a fantastic performer since the beginning of the year.

We have with Terumo and Coloplast, two companies in the portfolio that provide supplies to hospitals for different treatments; Ecolab is a company that makes chemicals for hygiene, including hand sanitizers, which is also very topical right now.

Within IT, we saw strong performance from companies active in cloud computing and the digitisation of our economy. We hold Microsoft, which is a big player in cloud computing. One of the bigger risks for Microsoft on the environmental side is carbon emissions. It also announced recently that it will offset all the carbon emissions it’s ever made, so it’s a very positive signal from that point of view.

Meanwhile, with eBay and Adyen, we also hold two companies that are offering solutions for, and benefiting from, the transition from a bricks-and-mortar economy to an online or digital economy.

Contrary to its competitors MasterCard and Visa, Adyen is a payment solution provider that’s fully focused on digital.

Why aren’t you invested in a company like Tesla, for example?

Tesla is a difficult one to get through all the steps in our investment process. It’s a very thematic stock obviously, I mean there's no doubt that our economy will be electrified going forward. Many of the products that have used fossil fuels in the past, like heating, but also transportation, like cars, will actually move to more electric solutions rather than using fossil fuels directly.

And Tesla has been a fantastic company from the point of view that it has been a very important disruptor. It has changed the whole automotive industry. If you look at all the research and development spending now, it's happening in two areas in the automotive industry: electric vehicles and self-driving cars. But also in terms of the barriers to entry and competitive advantages, Tesla ticks all the boxes.

Where I do have a bit of an issue is on valuation and governance. Tesla is not actually a very well-run company. It's been a company that had great vision from Elon Musk but has very poor social practices and governance around the management team. It's improving, but it's not to the standard that I would like to see. And on valuation, I would say it's priced to more than perfection. Obviously, it's gone down quite significantly now as well.

So, on balance, I’m not invested in Tesla at the moment for those two reasons. And those reasons sort of exemplify the philosophy of the strategy. Because it's important to construct a portfolio around the things you really believe in. Many people construct the portfolios around the benchmark and want to get exposure to every sector, every region in that benchmark. That's not what we do.

We only invest in companies we like, and we like them because they have the right products to benefit from important long-term trends, are well managed, don’t take irresponsible risks and can contribute positively to the ESG profile of our strategy. I think it's really important to construct your portfolios around the things that you'll believe will create that sustainable, long-term future.

Past performance is not a guarantee and not indicative of future results. Portfolio composition can evolve over the time. The views and opinions expressed may change based on market and other conditions. They are not necessarily indicative of the future or likely performance of the fund.

This interview took place in April 2020

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