The COVID-19 coronavirus pandemic and its tragic human cost have catalysed a response from governments, and public and private institutions around the world on a scale and with an impact that are unprecedented in peacetime. The engineered shutdown of large parts of the global economy, while needed to constrain the spread of the virus, has led to a demand shock that has dealt a blow to many businesses.
The economic and human impact of the pandemic has refocused investor attention on two key questions:
- What does it mean for a business to be truly sustainable or resilient?
- Will we see a green or sustainable recovery? Or will sustainability take a backseat to economic revitalisation?
Sustainability and resilience in volatile markets
Business resilience is at the core of sustainable or environmental, social and governance (ESG) investing practices. A common objective of integrating ESG into fundamental investment practices is to improve how risk can be identified and mitigated. This means considering a broad range of financially material issues that traditional financial analysis may capture. It can involve extending analysis beyond traditional measures of economic performance to include a focus on how different stakeholders such as providers of capital, employees, the government, communities and the environment are treated.
If the scales are tilted too far in the direction of one group of stakeholders, it can build in a source of long-term business vulnerability or inequitable outcomes – balance is key.
For example, incentive structures and a focus on short-term performance could contribute to a company ‘over-optimising’ the balance sheet to enhance returns to providers of capital. This could make the company more vulnerable to economic variability and leave it without a ‘cash cushion’ – resulting in staff layoffs and potentially a government bailout.
So how have ESG funds performed during the crisis?
In the first quarter of 2020, the four MSCI ACWI ESG indices outperformed the broad MSCI ACWI index by between 70bp and 290bp. Analysis by Morningstar of the performance of 206 sustainable US funds during 1Q 2020 supports this outcome: 44% had top quartile performance against peers and 70% had top half performance against peers.
Although the resilience of ESG investment strategies and indices has been encouraging to date, the value of ESG analysis to an investment process should be evaluated over longer-term periods. The risks and opportunities identified may be structural or long-term in nature (e.g. energy transition away from coal/fossil fuels) and may take time to be reflected in asset prices. This disconnect creates opportunities for ESG investors, but it is important to be conscious that other factors can dominate share price movements over short periods.
Building a sustainable recovery
There has been a wide range of approaches to economic recovery plotted by countries globally – from doubling down on green and equitable economic development to supporting new coal-fired power generation assets as a vehicle for economic growth.
As the world gradually reopens for business, and billions of dollars of financial stimulus are deployed, will we build for the future or just focus on the present?
The economics of green and renewable energy solutions have been improving rapidly and could represent an opportunity to direct economic stimulus to enhancing the transition towards low or no-carbon alternatives such as solar and wind energy.
Public support of sustainable investment appears to be becoming more mainstream. Despite the uncertainty and volatility during the first quarter of 2020, US sustainable funds saw a record quarter of inflows at USD 10.5 billion. This illustrates both the shift in consumer and investor behaviour and the rapid growth and availability of sustainable investment products.
Preserving a coherent global approach
Just six months ago, the idea of a lockdown and closure of entire segments of the economy would have been unthinkable. The global response to the pandemic has highlighted the scope and power of what can be achieved with strong resolve and coordinated effort in the face of a salient threat.
The danger from coronavirus is clear and present, but may be dwarfed in the long term by the impact of the climate emergency. With this in mind, when we emerge from the current predicament, a key question will be if the collaboration and focus can be maintained and harnessed to address the climate crisis or other global issues requiring a focused and coordinated response.
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.
Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).
Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.