The rise of ESG led Investing

The current pandemic had laid bare the vacuity of the hyper financialisaton that society has undergone during the past two centuries. However, headlines foreboding a doomsday scenario – ‘GDP shrinks by 20%! – are a cause of unnecessary despair.

While the human and economic cost of the crisis has been awful, a small silver lining is that in order to ensure the continued prosperity of future generations, the investment community is waking up to the fact that we need to manage our collective resources in a more sustainable way.

Thus, it seems that the current pandemic has provided continued impetus for institutional investors to remain focused on both the social and environmental impact of their strategies.

Momentum gathering

While impact dedicated funds are most certainly in their infancy, funds which use some sort of ESG overlay are increasing in popularity, with ESG index funds, now accounting for 20% of the index market.

The headwinds have been gathering momentum for a while, with BlackRock saying it will seek a tenfold increase in sustainable investments over the coming decade in a move that rocked the industry. Nor is this an isolated incident, as according to the UK National Advisory Board on Impact Investing, one fifth of insurance companies and pension funds, including AXA and UBS, have similar plans.

Elsewhere, in May, the world’s largest sovereign wealth fund, Norges, divested from 7 oil and gas exploration companies. While the move is said to be predominantly motivated by the fund’s strategy to shield itself from a long-term fall in oil prices, it follows a wider shift away from fossil fuel producers, in line with a growing recognition of the impact of climate change.

In terms of performance, there is an increasing body of evidence which finds that sustainable companies should have lower declines due to lower incidence of controversies and occupational mishaps, greater loyalty from customers, employees and even shareholders; often paired with more conservative balance sheets.

Furthermore, the pandemic has illustrated that high scoring ESG stocks outperform in a bear market.  For example, it is interesting to see that the MSCI ESG Leaders indices have outperformed their mainstream counterparts in most geographies, albeit modestly in most instances. The UK is the most striking example with the FTSE 100 ESG Leaders index returning -27.3% year-to-date compared to -33.7% for the FTSE 100 index (source: BofAML European Equity Strategy, Bloomberg, as at 24 March 2020).

Research by BofAML also finds that the top 20% of ESG-ranked stocks outperformed the US market by over five percentage points during the sell-off. Interestingly, this was not just down to a sector bias.

Increased role of Civil Society

The increased prominence of sustainable related causes in popular media has led to greater awareness of the existential threat of climate change, social injustice and so on. According to research conducted by Boring Money, since the on-set of the pandemic, two-fifths (40%) of advisers and consumers have reported a higher interest in sustainable investing as a result of the coronavirus outbreak.

In the Great British Sustainable Savers Census survey, which was sent out to 19,000 advisers and 5,000 consumers, 89% of 18-44 year-olds said it was important that a fund manager offers sustainable investment options.

Meanwhile, more than 83% of consumers said they would value a conversation with an adviser about sustainable investing. Finally, 58% of investors were aware of the term “sustainable”, but only 30% were aware of ESG investing, which perhaps points to a perception/marketing gap.

Thus, we can see that a broad cross section of stakeholders have an interest in sustainability and ESG considerations.

Sustainable Investing (SI) trends

We believe that there are several trends which will play out against a backdrop of expected low global economic growth as a consequence of the COVID-19 pandemic.

There will be some level of continued political support for recovery planning that emphasises a more resilient future, as well as strengthening SI regulatory frameworks in some regions (especially Europe and South East Asia), which were undergoing development before this global crisis. Consequently, we expect to see the growth in SI assets under management (AUM) of recent years to continue even in a very different economic environment.

Increased investor focus on ESG considerations

COVID-19 has elevated the importance of how companies operate and accelerated the growing relevance of ESG considerations to investors.

Corporate management of issues such as human rights, employee wellbeing, and community relations are under scrutiny, as issues that were considered luxuries in the past (e.g. flexible working models) have become critical business continuity mechanisms during this current pandemic. Such actions could have lasting impact on their reputation and future relationships with customers, vendors, regulators and investors. A pertinent example is Boohoo, which saw its share price fall by almost 50% amidst revelations of sweatshop labour. This points to a wider trend of investors using their influence to drive behavioural changes, in a sign that shareholder engagement should remain a key component of sustainable investment going forward.

The Increased Importance of “S“

Environmental concerns have long been the focus of ‘sustainable’ investors, however the COVID-19 pandemic has brought into focus the need to address social issues, and therefore we expect to see a shift as governments seem to address social issues. In addition, the BLM movement has also brought to the fore issues of social injustice, and the reduction of inequalities within and between societies.

Private Equity (PE)

Even within the PE world, ESG considerations are taking an increasing importance. Whether this is a marketing ploy or mere green-washing is debatable, but at least the discussion is taking place.

In any case, it is becoming increasing evident that, in a world with finite resources, ESG centric investing makes sense.

Historically the PE space lags way behind the public securities space, and it is within this melee that we see the real opportunities. Private companies which score highly on ESG metrics, or those which have the potentiality to score higher in the future will outperform their peers, in much the same way as has been shown for public companies.

Summary

ESG considerations have been gaining in importance over the past few years – e.g. new regulations coming into place to reduce plastic waste – but the focus has primarily been on the ‘E’ aspect of ESG. The COVID-19 pandemic and social justice movements have brought to the fore the importance of ‘S’. Therefore, we expect ESG considerations to permeate more ‘mainstream’ investors. Within this, there is increasing evidence that public securities which score highly on ESG considerations outperform their peers, making ESG centric investing ‘good investing’.

Finally, the traditional PE firms have lagged public peers in embracing sustainability, but we expect this gap to narrow. We feel there are many opportunities to invest within the PE space using an integrated approach and we expect companies that adopt this more holistic vision to outperform peers. In particular, we advocate the elevated importance of ”Social” for companies and investors, such as reducing inequalities, whether they be ethnic or gender based.

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