Quants Corner - The cure for the coronavirus? Investors think it is ESG

The cure for the coronavirus? Investors think it is ESG

With the coronavirus that originated in China renamed COVID-19 and spreading briskly, the final week of February was a brutal one for global markets. Benchmark equity indexes racked up daily losses at a rate last seen at the height of the 2008-09 financial crisis (see chart below).

Flows to EPFR-tracked mutual funds and ETFs reflected this malaise. Investors, whose initial reaction to the epidemic was measured, responded aggressively to the latest market signals. Redemptions from all Equity Funds jumped to a 22-week high while, on the fixed income side, outflows from Bank Loan, High Yield Bond and Alternative Funds hit 39, 54 and 70-week highs respectively.

Looking at the flows through a variety of quantitative lenses, however, uncovered some points of light in the general gloom.

The search for silver linings

Not surprisingly, the late February sell-off affected high-beta funds to a greater degree than low-beta funds. Less intuitively, funds managed for value fared worse than those with a growth mandate.

The table below shows the average return for growth equity funds in excess of the return for their value counterparts (purple bars). It also shows the average return for the top third of equity funds, ranked on 52-week beta versus the S&P 500, over the return compiled by the less volatile bottom third.

Another filter showed that large firms outperformed smaller ones during this period and that funds which attracted money did better on average than those that experienced net redemptions. The chart below shows returns to large equity funds in excess of the return for small funds and the returns to the top third of equity funds when ranked on prior four-week flow percentage over the bottom third.

Finally, the period between February 24 to 28 saw investors ploughing money into socially responsible (SRI) and environmental, social and governance (ESG) funds. They also showed a preference for funds that were swimming against the overall tide when it came to flows. The chart below shows (a) flows into SRI/ESG equity funds in excess of those of the other funds and (b) flows into the top third of equity funds in excess of the bottom third when funds are ranked on prior four-week flow percentage. (In all cases, flows are expressed as a percentage of assets under management.)

Connecting the dots

Intriguingly, although investors were willing to pour money into SRI/ESG funds, the returns for these funds were rather mediocre. This can be seen from the table below which shows relative flows and returns for SRI/ESG equity funds in excess of those of non-SRI equity funds.

It appears that investors are equating the extra layer of due diligence that goes into deciding if an asset meets SRI or ESG criteria with increased protection from volatility. As a result, the large cap technology stocks that make up a significant portion of the holdings in SRI/ESG funds are being viewed by these investors not as potential fuel for another ‘dot com’ bubble but as low beta plays with some growth potential.

Hence, for at least this week, funds with SRI/ESG mandates and significant exposure to large cap technology stocks have proved to be the most resilient. That is reflected in the relative outperformance of Large Cap Growth Funds and the strong flows into SRI/ESG funds.

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