In light of the recent coronavirus pandemic, the question on the minds of many is how the recent trend of asset managers taking environmental, social, and governance (ESG) considerations into account will weather the storm.
While skeptics of ESG might think the two-headed monster of global pandemic and economic strain the world has experienced almost since the beginning of 2020 will wreak havoc on the cause for responsible investing, evidence is suggesting that the opposite may be true. Research provider ETF Flows says ESG investments are continuing to grow, up $15 billion in the year’s first two quarters of 2020. In fact, during these difficult times how companies act to support their customers, employees, and other stakeholders is expected to be even more closely scrutinized, and investors are likely now more than ever to be held accountable for which companies they invest in.
What is ESG?
ESG stands for environmental, social, and governance, and the acronym has become shorthand for investment methodologies that embrace these factors as a means of helping to identify companies with superior business models. ESG factors offer asset managers added insight into the quality of a company’s management, culture, risk profile and other characteristics, by looking at non-financial information to identify potential risks and rewards. Those using ESG analysis may seek to identify companies that are leaders in their industries, well-managed, forward-thinking, meet positive standards of corporate responsibility, are better at anticipating and mitigating risk, and are focused on long-term development. Growing evidence suggests that integrating ESG factors into investment analysis and portfolio construction may offer investors potential prolonged performance advantages, with the United States SIF Forum for Sustainable and Responsible Investment estimating that from 2016 to 2018 socially responsible investing funds increased by 38% to $12 trillion nationally, and ESG is on track to grow 40% faster this year than it did the previous year in Europe.
Clement Perrette, a French financier with over 25 years experience working with Europe’s capital markets, has seen his own company RAM Active Investments SA recently launch a fund with the objective to tackle the climate emergency and to provide investors an active strategy with strong ESG standards. The asset management company has developed an innovative approach, using machine learning within artificial intelligence for their extensive research exploring alternative data. For Perrette and RAM Active Investments, the climate change emergency is a growing concern and they hope to use their role in asset management to provide investors with a unique solution to low-carbon investing. Below, we explore the points that Perrette believes are necessary to be aware of when thinking about ESG.
Covid-19 has brought the “social” aspect to the forefront
Companies and investors alike have come to understand the importance of governance, and with climate change being an increasing global concern, environmental factors have also received a lot of press and shareholder attention. However, as companies have dealt with Covid-19, the “S” of ESG — the social considerations — have come to the forefront of the conversation. How companies deal with employees, engage with their customers, and manage their supply chains are all social aspects of ESG, and when the coronavirus outbreak and subsequent lockdown forced companies to move their operations remotely, those who had not taken the time previously to develop strong networks and cybersecurity practices were met with considerably more difficulties than those who had a robust remote-working infrastructure already in place. Additionally, while the definition of what makes a company “socially responsible” can vary greatly from person to person and often result in a heated debate, it should be safe to say that most can agree the way a company treats its employees is a social good. Companies that had sound employee sick-leave policies already in place were better positioned to deal with Covid-19 than those that had to scramble to develop them in response to the pandemic. Non-essential businesses that refused to close or stagger shifts to reduce employee exposure, or failed to provide additional cleaning or protective equipment may not only find issues from a deliverable standpoint, but also negative PR, both of which can cause considerable revenue pain. Indeed, it is important to remember that the social component of ESG can be just as important a factor to consider as environmental and governance ones.
Purpose and profit are now intertwined
In a recent survey by Accenture and the World Economic Forum, 61% of the 20,000 young emerging leaders surveyed said that business models should be pursued only if they improve both societal outcomes and profitable growth. In addition to this, studies show that younger investors tend to favor investments in companies that are good global citizens. When it comes to corporate goals, profitability and social usefulness are now interdependent, and asset managers and independent investors alike need to hone their positive and negative screening skills and actively choose to invest in companies that are trying to aid or benefit society while avoiding firms that don’t hold up to the scrutinization of their social and environmental factors.
Today’s consumers are also focused on supporting companies that have a good track record for social responsibility, with 70% wanting to know what the brands they support are doing to address social and environmental issues according to a survey by Markstein. This has only been exacerbated with the onset of the coronavirus pandemic and economic downturn, resulting in consumers with higher levels of scrutiny who are even more likely to focus on what really matters and reduce consumption that is less sustainable. As a result, companies with a greater focus on sustainability have weathered the storm better than industries with weaker sustainability profiles such as energy and leisure. In addition to consumers, investments have increasingly become more personalized, as individuals look to holding a portfolio that reflects their chosen social and environmental causes. Needless to say, purpose and profit have become inextricably entwined and the lines between them will continue to blur as time moves forward.
Lack of standard metrics and data availability continue to create barriers
Two of the problems that exist with ESG investing are that the term means different things to different people and there is little coordination between the third-party rating systems. Rather than a standardized set of criteria or checklist to follow, an ESG strategy is fluid and can differ greatly from company to company. The resulting knowledge gap has seen most learning as they go along, with many firms just now starting to embrace the value of setting their own strategy. There are numerous ESG reporting standards and frameworks available in the market — GRI, IIRC, SASB, TCFD, UNGC — but these have long-confused both companies and users of such reports, with many referring to them as an alphabet soup of standards that are not well harmonized. Additionally, a company that may be considered good on one or two of the three ESG factors could fall short in another, an example of this being Tesla which earns a high rating within the environmental metric but may be judged poorly by some when it comes to governance. There is no tried and true recipe for ESG — instead it is about determining what issues are material for each company and industry and making decisions based on those factors.
ESG factors can help manage risk and potentially generate long-term value
The coronavirus pandemic has cast ESG practices into the spotlight, providing an intensified look through crisis at how companies responded and fell short to aggravated conditions. It highlighted the ability of ESG factors to help us better understand corporate resilience to such shocks. The most resilient and sustainable businesses thought about risks and managed them before they caused revenue or reputational losses, and will continue to do so whether that be abrupt ones such as Covid-19 or longer-term risks such as the potential for climate change to affect business. For asset managers whose main goal is the appreciation of a client’s assets over time while mitigating risk, ESG practices remain at the heart of the matter.