Written by Jon Duncan, Head Of Responsible Investment, Old Mutual Investment Group
At the time of writing, the COVID-19 crisis is impacting global markets, interrupting global supply chains, drying up demand and, of course, taking a massive personal toll on affected families. Given the scale of the devastation, some investors might ask, why worry about Socially Responsible Investing or Environmental, Social and Governance (ESG) issues at this stage? Surely it makes sense to just focus on the “important” investment numbers and rather leave the soft ESG stuff for after the crisis?
Strengthening the case for Socially Responsible Investing – lessons from COVID-19.
Lesson 1 – We’re all interconnected
One of the founding principles of Socially Responsible Investing (SR) is the interconnected nature of our social, biophysical and market ecosystems. Importantly SR recognises the impact of unpriced externalities on the safe operation of the market, society and environment. Examples include the social and environmental costs from burning fossil fuels or societal health impacts of high-calorie foods. By considering externalities in its approach, the SR field essentially asks all participants in the investment value chain to consider the wisdom of pursuing short-term returns at the expense of long-term resilience of social and environmental systems.
The COVID-19 crisis has laid bare the very real interconnectivity between our social, environmental and market systems. The lesson here is – don’t neglect interconnectivity and long-term system resilience.
Lesson 2 – Shared value
COVID-19 puts a sharp focus on management approaches to human capital management, corporate culture, and the treatment of customers. Corporate responses around these issues can potentially have lasting impacts for all company stakeholders. For investors that are ESG literate, it’s no news that workforce management, employee satisfaction and corporate culture have a long- term impact on productivity, share price performance and returns. Similarly, that companies’ treatment of customers is an important driver of brand equity and improved customer relationships over time. How management teams respond in this time of crisis will be telling for their long-term profitability. Aside from management practices, the COVID-19 crisis also exposes the underlying business model, specifically what goods and services the company provide. As we are collectively finding out, essential services means something very specific. It redefines what we can and can’t do without, and what we are prepared to pay for. Business models that solve for food security, connectivity, online education, entertainment, sustainable mobility, finance, water, energy, sewage, waste, healthcare, etc have prospects for growth.
Those investment teams with deeply integrated ESG processes will no doubt be attuned to these issues. They will have a view of which business models and management teams are therefore best placed to retain value through the cycle. COVID-19 has been indiscriminate in whom it infects, and doing so it has become everyone’s problem. Those with the best chance of fighting it are doing so collaboratively across a broad range of stakeholders. The COVID-19 crisis reminds us of the power of working proactively with all stakeholders to achieve shared value outcomes.
ESG is not just a nice-to-have but it is also a good to have
Old Mutual Investment Group has long maintained that analysis of ESG issues can, and does, drive long-term investment performance. It is not just a nice- to-have, it is a good-to-have. We see sustainability as a macro thematic trend that is fundamentally reshaping the competitive landscape across all sectors. Companies that respond to this trend early enjoy stronger social licence to operate, lower staff turnover, better resource efficiency, lower cost of capital, better innovation and stronger access to market.
As a group, we have invested in building out our product offering to capture this theme through a series of ESG indices. These funds have attracted inflows in a manner that is consistent with the growing global trend. Sustainable investing has grown exponentially in the past five years. For example, in the US, the net flows into sustainable funds reached US$20.6 billion in 2019, more than four times the previous annual record that was set in 2018.
Like all funds, sustainable equity funds suffered large and sudden losses of value in the first quarter of 2020 due to the global coronavirus pandemic. However, Morningstar reports that sustainable investment funds held up better than conventional funds during this period. They report that seven out of 10 sustainable equity funds finished in the top halves of their Morningstar categories, and 24 of 26 environmental, social and governance-tilted index funds outperformed their closest conventional counterparts.
This is also evidenced by the MSCI ESG index tracker funds that Old Mutual offers, which have shown resilient performance over the past quarter. Figure 2 shows the cumulative returns of the MSCI Emerging Market ESG Index to the end of March 2020. An additional point to consider in the “good to have” bucket is that ESG fund flows remain intact. Research from Band of America Securities indicates that while there has been record ETF selling over the last few weeks (Chart1), ESG funds have seen inflows for ten straight weeks (Chart 2).
Even after the market sell-off, ESG ETF assets under management (AUM) are still up nearly 5% year to date, while S&P 500 ETFs have seen AUM decline by over 30%.
In Europe, ESG funds have seen persistent inflows including recent months, even amid EU stock outflows.
Perusing green growth
As society seeks to rebuild in a post-COVID-19 world, we expect the idea of green growth to continue to gain traction. The notion of green growth emerged after the last financial crisis and envisages an alternative growth path guided by climate awareness, resource efficiency and social inclusion. At a global level, green growth features in national growth strategies and the EU is putting in place legislation to drive and incentivise these kinds of outcomes.
Green growth is not only a scientifically bounded economic idea but is also a set of globally consistent consumer preferences, as more and more consumers align with the sustainability agenda. Doing more with less has always been a good idea, as has caring for the environment along with being a good neighbour. As such, we expect demand for “green” assets to grow beyond the institutional market to the retail market as well. Asset managers that have green growth capabilities and assets, will have an advantage over their peers as the world seeks to re-normalise in a post-COVID-19 environment.
It is not clear what’s next. The COVID-19 pandemic is unprecedented in modern times. There is much we don’t know about how this will play out. However, what we do know is that the world will be much changed. Our sense of interconnectivity will be enhanced, we’ll have learnt that it’s not just returns that matter, and that businesses that focused on long-term outcomes will be remembered. Sustainable investing is about delivering competitive financial returns by leveraging ESG insights. It is also about shifting the global economy to a path that is low carbon, resource efficient and socially inclusive. Now, in the midst of this crisis, is the perfect moment for all actors in the financial services sector, whether they be advisers, consultants, asset owners or asset managers, to realign their understanding of SR and ESG issues. It is critical that decision-makers should be clear on how ESG issues affect long-term risk and returns, and additionally how the growing trend towards sustainable investing impacts the ability to attract and retain capital.
Moneybox has partnered with Old Mutual Investment Group to introduce a Socially Responsible fund, featuring environmental, social and governance (ESG) scoring.
About the author
Jon Duncan | Head Of Responsible Investment, Old Mutual Investment Group
Jon Duncan leads the Responsible Investment division at Old Mutual. The Programme is focused on driving the systematic integration of material environmental, social and corporate governance (ESG) issues across the Old Mutual Investment Group.