You might as well face it … ESG test time?

ESG undoubtedly reached Prime time against a backdrop that featured a once in 100 years Pandemic; rising concerns about inequality stoked by unprecedented levels of stimulus (monetary AND fiscal), social injustice and discrimination, as illustrated by the Black Lives Matter movement.

Welcome to 2022 …

With 2021 wrapping up a strong year for equity markets at the index level (with many cracks under the surface, particularly from November 2021 onward, mind you …) ESG no doubt, after the latest Climate Change Summit held in Glasgow in early November, was poised to be a topic garnering continued interest on the part of Advisors and clients looking to align their investing with their social and ethical aspirations.

The industry had obliged in a big way, with resources across firms growing rapidly alongside significantly expanding product shelves, notably on the ETF side, including not just equities, but bonds related solutions, and in fact one ticket ETFs solutions as well.

By all accounts, the ESG movement was well underway, and poised to attain greater heights of uptake and significance, driven in no small measure by rising awareness of the ever dire consequences forecast the world over with regards to climate change should we fail to heed the call.

ENTER – Sharply rising Energy costs; by now no longer described as transitory inflation spikes; and, finally, a brutal aggression of the Ukraine by a Russia intent on redrawing the maps of Europe, and … unfortunately, and literally … boom; Berlin; Washington; London; and whatever metropolis you fancy inserting here … WE HAVE GOT A PROBLEM!

The problem, in essence, revolves around Energy supply security; Energy “sufficient” (respectively insufficient) availability; and, by now, unfortunately … what must be the stark realization that the “transition” thus far toward that wonderful carbon neutral world of 2050 … is being rather poorly executed!

Net result?

Market dynamics look to have changed significantly, with the importance of sector exposure dwarfing that of factors, and thematic undergoing what has been for months now a brutal bear market.

What of ESG? Well – given in particular the magnitude of performance contribution brought forward by Energy, could it be investors might suspend their trip down “conscience” lane (or “Idealism”?), opting instead for the near term to focus on the dynamics favoring Energy for possibly months and years to come? It will be interesting to see. From my perspective, important is to realize that they do not have to be either mutually exclusive, nor at odds with one another, even though on the surface politicians would have us all believe they do. The fact is, it would be much wiser to consider them on a continuum of what we’re going to need to get to a better place – environmentally speaking (and hopefully socially as well, where much work is also needed as both capitalism and democracies don’t seem to serve all equally well … another story … another day …).

Anyways, with that rather long preamble – my apology – I will now simply present a few tables which I believe illustrate the changing dynamics underway currently, in a very difficult (and very sad, with Russia’s murderous acts of genocide in the Ukraine) context:

Factors (in Canada): NO CONTEST:

  • Value dominates, with significant “overweight” to Energy relative to the TSX Composite (166.7% as at 19/3/2022)

  • Value dominating; Fundamental indexing coming in slightly behind, with very sizeable financials overweight, but also meaningful Energy and Materials “content”
  • Dividend not far behind (many names in that category are generally “value” and … no surprise really … also some energy exposure here as well, which may well grow in importance going forward),
  • Min Volatility, Low Vol: both trailing (but notably Min Vol ahead of Composite on … again, sector weightings methodology/criteria)
  • ESG and Growth slightly to the negative, or more meaningfully lagging (will that cause some rethink as far as allocation in the near term, or present a challenge to unbridled uptake?)

Sectors – recent dominance is hard to overlook …

  • Energy
  • Materials
  • Agriculture
  • Gold

Sounds familiar? Unfortunately war in Europe isn’t helping, and certainly isn’t going to help us with inflation …

  • Financials – until recently very strong, but now? worries about markets, worries about the economy = … on pause?
  • Tech – the drop from early November 2021 has been nothing if not brutal and very sharp, including the first two months of 2022
  • Utes; REITs and staples => the usual safe haven in uncertain times …

Bottom line:

the bungling of the Transition, and, in part due to it, the Energy crisis currently unfolding – unfortunately further exacerbated by Russia’s acts of war in Europe could represent a significant headwind to ESG gaining strong traction in 2022. The Geopolitical considerations brought forth by the war is resulting in sector consideration overwhelming factors and thematic investment frameworks. Many clients and Advisors may be asking themselves how to position to look at ensuring proper diversification, in order to address concerns related to risk, as well as inflation’s damaging impact on their portfolios. To boot, fixed income doesn’t appear in the current context, to be well suited to sufficiently offset overall risks embedded within the traditional (incl. the omnipresent 60/40) portfolio construct.

Hopefully the relative performance information presented here provides useful context when you seek to catch up with what market dynamics have brought to the fore thus far in 2022. Be careful out there. Gold seems to have awaken; inflation isn’t going to be vanquished a quarter point at a time, and at the other end of that, the risk of policy error on the part of the FED increases challenges for equity portfolios overall. And we aren’t even here touching on international and emerging markets … Fun… On the + side, Canada’s stock market is generally well positioned for this climate of greater commodities needs, and inflation-hedging needs, as well as a steady Financials services space. Not everyone is as lucky. Home bias, this time around – to be embraced …