What does COVID-19 mean for ESG investing? May 2020

Gabriel+wilson otto

Gabriel Wilson-Otto, BNP Paribas Asset Management head of stewardship for the Asia Pacific region, believes that we have a chance to radically reshape global economies coming out of the COVID crisis in a way that highlights sustainability.

He's hosting a webinar on the economic impact of the current turmoil will have on ESG investing and the role of stewardship as we navigate the road ahead. He answered a few questions from Industry Moves about what the world could look like in the not-too-distant future.

Have sustainable investments been performing well in the current extreme market volatility?

Globally, the data that I have seen is encouraging. In the first quarter of 2020, the four MSCI ACWI ESG indexes outperformed the underlying MSCI ACWI index by between 70bps and 290bps. This outcome was also supported by analysis by Morningstar of 206 sustainable funds in the US funds during 1Q2020: 44% had top quartile performance vs. peers and 70% had top half performance vs. peers. Although the resilience of ESG investment strategies and indexes to date has been encouraging, the value of ESG analysis to an investment process should be evaluated over longer-term time horizons. 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 some 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 time horizons.

Are there any corporations that have had a notably strong response to the current crisis?

The impact on individual corporations, as well as their responses, have varied significantly. In terms of corporate impact, the key determinants of the impact have largely been a combination of: a) financial leverage; b) operating leverage; c) the magnitude of the demand shock; and d) extent of government or 3rd party support / investment. To an extent, these factors are determined by sector exposure – but they can also be influenced by corporate actions, in particular the magnitude of financial leverage.

Positive corporate responses are broadly divided into 3 areas: 1) Treatment of staff and supply chain partners; 2) Support of disease prevention in local communities; and 3) providing financial or other support to front-line medical staff or research. There have been numerous examples globally, and within Asia Pacific specifically, of corporate support in these three areas. However, some firms appear to have made a strong distinction between supply chain partners vs. in house employees with cancelled orders and lack of support (e.g. Bangladesh apparel supply chains).

Socially responsible investing was viewed in the past as a trade-off, performance for making a difference. Do you see there being a shift in this mindset post-Covid?

Historically, SRI investing has been focused on impact or values-based investment strategies. This resulted in either excluding certain sectors or practices from a portfolio, or deliberately attempting to maximise the impact of your investment in a chosen area. By definition, these two objectives may not be targeting alpha maximisation – historically, the key driver of sector exclusions from an investment strategy was a ‘values-based’ decision, and impact investment can deliberately target a lower return to maximise positive outcomes. However, over the last decade, this mind-set has been changing as ESG & sustainability issues analysis enters into the mainstream. ESG integration is not about a trade-off (e.g. ESG or Alpha), but recognition that ESG analysis can supplement traditional investment insights and contribute to enhanced assessment of risks and opportunities. This is also supported by a wide range of academic research highlighting the relationship between sustainable investment practices and lower volatility and improved risk adjustment returns.

COVID-19 has the potential to be a catalyst for further acceleration in the adoption of ESG investment practices. We note that 1Q2020 was a record year for inflows into sustainable ETFs in the US (albeit March was slower than January), and that RIAA has seen a sharp increase in demand for fund certification highlighting domestic demand for ESG products. In our view, there is a strong relationship between Sustainability or ESG and business resilience – the current focus on the human cost of the crisis, as well as the different impacts and responses from corporates, has refocused investor attention on what it means to be a truly sustainable and best in class business.

While we want to get back to “normal,” what are some things you see changing in sustainable operation and investing?

There are two interesting angles here: the first is the extent to which the availability or sustainable investment products and shifting consumer mindsets coalesces to drive a persistent step change in investor and corporate behaviour; the second is if the focus, determination and coordination to address the pandemic can be harnessed to deal with other challenges.

Just six months ago, the idea of a lock-down 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 threat from coronavirus is a clear and present danger, 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.

How do you define a “sustainable economy?” And, is it achievable?

I define a sustainable economy as an economy that achieves equitable and inclusive growth through balancing the competing demands of different stakeholders. This includes providers of capital, employees, the government, communities and the environment. If the scales are tilted too far in the direction of one group of stakeholders, it can build in a source of long term economic, environmental or social vulnerability. I am optimistic and believe that it is achievable, but balance among stakeholders is key.

Do you see bad actors, or companies that aren’t taking ESG into account, being called out?

Companies are increasingly being called out and held to account – this is likely to be a persistent trend, and amplified by both the shift in consumer behaviour and the towards sustainable investment practices with a stronger focus on active ownership and investment stewardship. The combination of the proliferation of smartphones, social media and an increasing focus on ESG issues (in particular from younger generations) now means that: 1) there is no such thing as a local issue – a human rights violation or poor environmental practices in a company’s supply chain can be globally distributed in seconds; 2) consumers and investors are increasingly speaking with their wallets. This is also tied to the rise of social media and the concept that conspicuous consumption is increasingly being tied to products or experiences that project an individuals desired value alignment.

What’s the purpose of your webinar, and what do you hope attendees take away?

The key purpose is to explore the relationship between sustainability and business resilience – historically, ESG investments have been seen by many as a source of philanthropy, however as ESG has entered into the mainstream, I will argue that there no-longer needs to be a trade-off between doing good and doing well. Shifting consumer preferences, the increasing salience of climate change, the urgency of the energy transition and the reality of COVID-19 have all highlighted the importance of a robust toolkit to assess risks and opportunities. ESG integration can supplement traditional analysis and increase the odds of identifying tomorrow’s industry leaders.

There is strong momentum behind sustainable investment practices, and the economics of key themes such as the energy transition are becoming undeniable. Robust ESG integration and strong investment stewardship practices can help generate differentiated investment insights and contribute to differentiated performance.

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