The coronavirus pandemic has caused investors worldwide to contemplate the potential for a much different investment landscape when the outbreak is finally behind us. Yet despite the many shakeups that global economies are currently experiencing, we believe investing with a strong focus on environmental, social, and governance (ESG) principles will endure – and will likely be a key aspect of the rebuilding that lies ahead. Lockdowns haven’t shut down responsible investing.
What might that future look like? How might we get there from here? And how could ESG strategies fit into it, and make a difference for the better? Here, Alessia Falsarone, PineBridge’s Head of Sustainable Investing and Senior Portfolio and Risk Strategist for Developed Markets Fixed Income, offers insight into what a post-Covid-19 “new normal” for ESG investing could look like.
Q: In what ways, if at all, have you and others in the industry changed your investment approach to ESG?
The outbreak hasn’t changed our investment approach, which is rooted in full integration of ESG dimensions from pre-investment due diligence through the monitoring of existing investments. If anything, it has made the value of ESG integration more tangible.
The Principles for Responsible Investment (PRI) have made it clear that investing through the ESG lens is here to stay. The Covid-19 pandemic calls for organizational introspection about ESG and a cohesive vision of how human and economic value can be created. The PRI states that “As long-term stewards of capital, investors can and should act now to help reduce harmful impacts, including the direct effect on public health, the severity of the associated economic slowdown, the deepening of inequality in societies, and the resulting impacts of all of the above on mental health1.”
The effort of reconciling human well-being with economic growth is not only worthwhile, but essential. The post-Covid-19 world is tasked with committing to the imperatives of environmental protection and social inclusion, while adopting a sound roadmap to sustainable financial outcomes. This is an uncharted journey we are embarking on together.
We believe investors must deepen their commitment to responsible investing at a time when some key longer-term environmental and social justice efforts may be rolled back or put on hold by regulators or governments as they shift resources to fight Covid-19. And when it comes to addressing socioeconomic and environmental concerns about business activities, the industry can lay the foundation for investment strategies that directly address those concerns now and in the future.
We don’t see evidence – in the fund management community or among asset owners – of responsible investors backing off from their ESG priorities during the outbreak. Rather, we see investors moving away from labelling financial and societal concerns as “ESG” and instead addressing the underlying risks across all portfolio allocations - regardless of whether they’re doing so to comply with client-directed mandates calling for incorporation of ESG practices.
Q: The coronavirus outbreak has created the first global economic slowdown ESG investing has faced since becoming mainstream. How do you expect sustainable fund investments will fare, and could they perhaps weather the turbulence better than traditional offerings?
We are experiencing a systemic disruption that is outside the realm of any traditional company-specific or sector-level headline that would cause near-term volatility – think, for example, of an oil well explosion, a major open-water contamination, or a severe health-related accident. Therefore, context remains key in addressing the resilience of fund investments as well as the time horizon.
Because the duration and degree of contagion of the coronavirus are ultimately the fuel driving the macroeconomic uncertainty the world faces, the ESG lens hasn’t been a consistent differentiator among markets at the onset of the pandemic. That said, many commentators have been eager to highlight the expected resilience of ESG offerings in terms of both performance and volatility of returns to support continued fund flows. Yet we need to recognize that no two actively managed ESG strategies rely on the same investment approaches or follow the same ESG metrics. Therefore, comparing ESG to non-ESG funds is not a simple straight line.
What we can state with some confidence is that, on average, responsible investors – those who actively address ESG risks as part of their financial evaluations – have tended to be more conscious buyers of value and direct avoiders of assets with deteriorating sustainability practices. With the pandemic emerging as a health crisis, it has been easier to test organizational readiness and the ability of management teams to think on their feet and move to protect their human capital in the short term – whether by implementing payroll protection or extended benefit schemes, foregoing dividend payments, or drastically reducing managerial incentives to support near-term financial liquidity.
In the longer term, we expect companies that have developed stronger ESG practices during the crisis to benefit from core allocations by investors and gain access to stable and diversified sources of funding at a more stable cost of capital.
One market segment to highlight is that of ESG-labelled bonds with dedicated use of proceeds to fund environmental or social projects, as identified by the issuing entity. Broadly speaking, these offerings have held up relatively well during the pandemic as a result of a sustained pipeline of primary market debt issuance. Solid corporate borrowers and supranational entities have brought to market green, social, or sustainability-linked securities – many to fund Covid-19 resilience programs – and demand has often outpaced supply. Buyer support post-issuance, coupled with consistent liquidity, give investors confidence in these issues’ inherently stronger credit quality profiles.
Performance-wise, from both a credit risk and a duration perspective, the fact that we haven’t seen a wave of downgrades affect these corporate issuers is a testament to their ability to define resilience measures as core governance indicators of enterprise value.
Q: Do you believe companies that have invested in strong business continuity measures represent more attractive investment opportunities?
Yes. Business continuity and resilience measures are core governance indicators of enterprise value. They are the backbone of a viable business – in private and public markets and across financial instruments.
Investing in business continuity planning (BCP) has traditionally meant maintaining adaptable business operations powered by distributed technology networks. What the health crisis has shown is that access to up-to-date information on the health and safety of employees and the reliability of supply chains is intrinsic to BCP – and that it requires metrics with predictive power that go beyond what after-the-fact incident rates can tell us. If these factors had not been consistent elements of investors’ due diligence before this crisis, they certainly will be now.
As in any crisis, one of the biggest risks for both society and the financial system is treating the outbreak as a one-time event rather than as an opportunity to refine preparedness plans and resilience strategies. In fact, what sets apart sustainable investment strategies is what I often call a “residual risk mindset.” When standard risk mitigation practices fail to address financial stresses that are harder to quantify, such as those posed by environmental and social factors, they may introduce significant residual risk potential for an organization. Investing in companies that exhibit strong governance surrounding BCP means aligning corporate responsibility with enterprise risk management as standard audit practices. Directors’ and officers’ incentives will likely be vital instruments in addressing any residual risk concerns.
Q: What issues most concern the ESG-oriented asset owners that PineBridge serves?
The concerns we are hearing generally fall into the following four key areas:
Uncertainty over the duration of the pandemic, the cushion provided by government interventions, and whether some sectors will be damaged beyond repair.
Potential shifts in attitudes about consumption and the long-term impact on consumer behavior, including the financial repercussions that a new “social contract” may entail.
Uncertainty over the liquidity needs that companies are able to fund in the marketplace at less attractive terms, and the willingness of capital market participants to support another round of financing at distressed conditions.
Whether governments will enforce higher transparency standards on companies operating through geographically dispersed procurement models.
Q: Have you seen any examples of how the crisis is prompting businesses to incorporate ESG-supportive behaviors?
Interestingly enough, technology companies have been leading the way in placing their systems and talent to work to tackle the health information void during the crisis – including some of the same companies that have come under severe scrutiny over the past few years for ethics, privacy, or data-protection issues. For instance, some have committed cash and ad credits to help small businesses, produced and donated personal protective equipment for healthcare workers and first responders, and offered to deliver and pick up at-home test kits. Some are even working with competitors in these efforts, including one partnership to create a coronavirus contact-tracing app.
These are just a few examples of leaders pivoting their businesses to address immediate societal needs. They also highlight how the same leaders could act swiftly and effectively to address other aspects of governance (such as privacy and data protection).
Q: What main ESG trends do you think will emerge from this crisis?
In the private sector, over the past two years we have already witnessed a marked pickup in collaborative engagement among investors (especially among PRI signatories). But stability of supply chains is likely to become a bigger priority, along with enhanced transparency about employee benefits and compensation structures in events of “force majeure” – especially in the context of stark differences in social equity from one country’s regulatory regime to another.
Covid-19 will leave the private sector with the clear need to operate in jurisdictions and geographies that are equipped to address the next pandemic and where minimizing casualties (people and processes) is the highest shared priority of lawmakers and investors.
A sustainable-return mindset has already begun to emerge – with the performance of sustainable business activities more clearly reflected in the enterprise value that capital markets assign to companies. Any form of discretionary capital distribution (executive compensation, dividends, and buybacks) will continue to be heavily scrutinized by investors post-crisis.
In the public sector, engagement with regulators and policy officials is also likely to gain significant traction among investors and other stakeholders. The role played so far by local governments in pushing for prompt health and safety actions may well continue post-pandemic. It could also encompass heightened standards for organizational resilience and preparedness practices, with a particular focus on social inclusion – in the context of both human rights and the setup of a health care system at the national and regional level that allows for the mapping of available resources and clearing of bottlenecks.
Expect governments to learn from successes and failures in their attempts to “flatten the curve” and apply the same scorecard to prioritize action in other potential social crises, such as food security and climate change. Investors will closely monitor the role of government intervention for clues about when to curtail it and enable free-market dynamics and consumer choices to be the guiding forces.
Most important, the pandemic calls for redefining the scope of economic output (GDP) studies and forecasts to include outright the evaluation of core ESG values: those of human capital, of innovation (as a technology-led growth factor), and of the economic viability of micro-, small-, and midsize enterprises, specifically when addressing competitive market behaviors and direct access to funding in times of crisis.
In addition, the familiar issues of a just transition while climate-proofing economies pre-pandemic has become even more tangible with the current health crisis. What emerges as a clear systemic hurdle is that pandemics don’t care about country borders. Our shared economic and human well-being are goals worth investing toward, and only concerted efforts on a global scale can make it happen.
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