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Thoughts on the Markets, the Economy and Sustainable Funds

Thoughts on the Markets, the Economy and Sustainable Funds

| May 27, 2020

Regular readers of our notes will recognize the phrase, "The markets discount fundamentals that are six-to-nine months ahead."  By this, we mean that investors are "forward looking", scanning over the chasm for the fertile fields in the distance. But are those fields really that fertile?  I have my doubts, of course. 


Investors may reasonably ask, "Why are stocks going up when unemployment is rising, earnings are falling and COVID-19 cases have continued to rise?" 

First, when it comes to unemployment and earnings, these headlines are lagging indicators.  They already happened.  These are in the rear view mirror.  Yes, high unemployment will be with us for years to come, but this is already built into investors' expectations and in current stock prices. 

And with regard to cases of the coronavirus, investors are increasingly optimistic that while cases may still be climbing, the rate of growth appears to be slowing overall.  Clearly, these trends could reverse, or stall, which presents a risk for investors who are aggressively buying into the markets.  Indeed, a second wave of infections is a real possibility, prolonging the economic slowdown versus the current expectations of a quick snap back (which I don't actually believe will happen so easily.)  

Fear has given way to greed, as it always does.  Investors often follow price "momentum", believing that "the trend is your friend" -- at least for a while until the trend changes again.  So, while we can agonize over how to "maximize" our returns, the other option is to build portfolios that are in line with our long term strategic plans and recognize that volatility is an unpredictable fact of life.  The best defense is to remain balanced in your allocations.


In this difficult period, it's heartening to see that sustainably-oriented investments have done better than most.  According to investment research firm Morningstar, over the first three months 2020, 70% of sustainable equity funds outperformed their peers. Their lower exposure to traditional energy investments is part of that outperformance.  (Recall that the price of oil plunged in Q1.)   They were generally overweight the technology sector (the top Q1 performer) and had a bias towards companies with stronger balance sheets.  All of these helped in the current environment.

As the graphic below shows, 44% of sustainable equity funds were ranked as top quartile performers in Q1, demonstrating their defensive characteristics.

My guess is that sustainable funds will post solid returns versus their peers through this crisis and beyond, but will have periods of underperformance when the markets inevitably rotate towards lower quality shares.  There is no investment approach that wins all of the time, of course.  But the sensible financial principles underpinning an ESG investment approach are also consistent with societal trends that have staying power over the long-term. 

Put another way:  Whenever possible, it's better to have the wind at your back.