The New Normal: COVID 19 and ESG Investing

Why Is COVID 19 an ESG Issue?

We live in unprecedented times. COVID 19 has prompted a radical reassessment of all aspects of human life as people are forced to adjust to the ‘new normal’ post-pandemic. Not only has the crisis triggered the worst global recession in nearly a century [1] it has also renewed discussion over the need for a more sustainable approach to investing.

Coronavirus itself may be considered a by-product [2] of unsustainable human investment activity – a consequence of biodiversity loss, rapid urbanisation, rising population levels and closer human closer contact with animals through deforestation and bushmeat markets.

The indiscriminate, yet acutely human impact of the virus has blurred the lines between shareholder and stakeholder value and well-placed the rapidly developing ESG market to benefit from a paradigm shift in investment philosophy towards sustainability.

Any change in direction may not need to be solely ideological, however. ESG funds have made an attractive case for themselves during the crisis, outperforming wider equities and showing resilience during the market sell-off. Sustainable funds attracted record inflows [3] of $71.1bn globally between April and June and new product development stood strong in Q1, with 102 new offerings [4] and further sustainable repurposing of traditional funds by asset managers.

Ideological Urgency: Commitments to Be More Sustainable

The pandemic has impacted the global economy at a pivotal time from an ESG perspective.

ESG integration was facing significant political challenges in the wake of the virus. In November 2019, the US (the world’s second-largest emitter of CO2) began the process of withdrawal from the Paris climate agreement, drawing condemnation [5] from environmentalists and statements of regret from world leaders. Global energy markets were already in turmoil and US oil prices fell below $0 for the first time in history in April as the virus hit global demand further, boding badly for the clean energy, biofuels and recycling plastic technology sectors.

On the flipside, in early 2020, asset managers and public companies issued significant commitments to sustainability. Larry Fink, CEO of Blackrock wrote in January that sustainability would be its ‘new standard’ [6] for investing. This built upon an August 2019 statement by Business roundtable – a group 181 CEO’s from some of the world’s largest companies – which presented radically modernized principles on the role of a corporation to move away from shareholder primacy and include a commitment [7] to all stakeholders. 2020 should also witness the EU Action Plan and the European Green Deal beginning to take effect.

Advocates agree that recovery is a time of great opportunity to integrate and realise ESG investment principles. The shift in company behaviour towards stakeholder value creation presents an extraordinary opportunity to meet a global need for better public health, more equitable access to labour market opportunities, and effective action to decarbonise the corporate sector.

Since the virus hit, the EU has led the way in policy efforts to ‘build back better,’ and has committed a portion of its €750bn recovery deal to sustainable projects. The European Commission has said [8] “investing in renewable energy and clean hydrogen solutions, clean transport, sustainable food and a smart circular economy “has enormous potential to get Europe’s economy growing”. Others may soon follow – DWS Research Institute predicts a greater focus [9] on the composition of fiscal stimulus programmes to include green investments. China has strengthened regulations regarding the proper treatment of sewage and industrial waste.

The EU has also dominated ESG fund flows since the beginning of the crisis. Morningstar reported that of $71bn of net new money coming into ESG-focused funds, $61.4bn was drawn from European investors. Leading investors representing €11.9 trillion in assets under management have also written [10] to European leaders, highlighting the need to ensure the economic response to the pandemic delivers a ‘green and sustainable’ recovery.

Elsewhere, a statement [11] from the Co-Heads of Sustainability & ESG Research at J.P. Morgan has called the pandemic a, ‘wake-up call for decision-makers,’ and draws strong comparisons between the impact of the virus and climate change. Major banks have also pledged [12] to align their portfolio of lending and investments towards asset owners who are determined to reduce their carbon footprints.

Strategic Sense: Outperformance and Opportunity

For sustainable investors, COVID 19 has gone a long way to debunk the myth that there is a performance penalty associated with ESG products.

The numbers have spoken for themselves – A Blackrock study [13] observed ‘better risk-adjusted performance across sustainable products globally, with 94 per cent of a globally-representative selection of widely-analysed sustainable indices outperforming their parent benchmarks in Q1.’ Morningstar also reported that the during the downturn in March, 51 out of 57 of their sustainable indices outperformed [14] their broad market counterparts.

ESG fund outperformance during the pandemic can broadly be explained by low portfolio exposure to the struggling energy sector and oversized allocations towards healthcare and technology. However, investors have also pointed to the resilience of companies with high social and governance credentials. Corporate behaviour such as choosing to maintain health benefits and salaries for workers powered outperformance as successful companies delivered greater employee satisfaction, strengthened customer relations and demonstrated board effectiveness in decision making.

To many, outperformance during a pandemic simply serves as another case study in a growing school of literature around the positive relationship between ESG principles and corporate fund performance over time. Recently released Morningstar research examining the long-term performance of a sample of 745 Europe-based sustainable funds shows that the majority of strategies have done better [15] than non-ESG funds over one, three, five and 10 years. Furthermore, a 2018 study [16] by DWS found a ‘highly significant, positive, robust, and bilateral’ correlation between ESG and corporate fund performance.

Conclusion: A Strong Recovery Must Be a Sustainable One

COVID 19 has called for a radical reassessment in the way governments, institutions and individuals think about investments. The impact of COVID 19 on the real economy and the financial system highlight the limits of most forecasting models and has illustrated the financial materiality of environmental, social and governance risk factors.

Considering stakeholder concerns when making investment decisions is today no longer regarded as “pure and unadulterated socialism” as Milton Friedman wrote [17] in 1970. Instead, according [18] to Larry Fink, ‘Companies and investors with a strong sense of purpose and a long-term approach will be better able to navigate this crisis and its aftermath.’

For many, this ‘new normal’ means taking a long-term, sustainable view on what really drives value in a post-pandemic world.

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