The world-weary view of the recent upsurge of interest in sustainable investing says that worrying about environmental, social and governance factors is a bull market luxury. In harsher conditions, you might think, attention will revert to harder-nosed issues like profits and capital preservation. You’d be forgiven for thinking that, but you’d be wrong.
Before the pandemic struck, responsible investing was a hot topic, with the main focus being on the E for environment and, in particular, climate change. It has become hotter still as Covid-19 has brought the S for social to the fore. And it is probably not coincidental that the G for governance is firmly on investors’ radars as well. Bull markets can hide a multitude of sins that then emerge during the tougher times that follow.
It is not hard to see why social issues should have become more pressing in the time of corona. The safety of workers and the provision, or absence, of protective equipment is front of mind and an illustration of why businesses and investors have rightly moved on from the discredited idea that ‘cheapest is best’. A purely financial, shareholder-primacy perspective might favour a supermarket chain that obliges its workers to put in longer hours without PPE equipment over one that focuses on customer and employee safety with social-distancing and appropriate protective kit. It’s pretty obvious today that this would be a dumb investment approach.
Another reason for social factors to have been pushed up the investment agenda is the way in which the pandemic has highlighted glaring inequalities. The death of George Floyd may not have received the attention it did were it not for the context of a disease that disproportionately affects black and other minority ethnic groups living on the economic margins in public transport, care homes and the like. Boohoo’s supply chain is not a new story, but Leicester’s lockdown has cast a harsh light on the exploitation of poorly educated immigrant communities with no better options than sweat-shop employment for a pittance.
The massive interventions by government in support of businesses and their workers has focused customers’ attention on actions as well as words from companies. The role companies play in their communities, and with respect to their employees and suppliers, has shot up the agenda in the boardroom. This is naturally even more the case where governments have taken stakes in companies, or handed them a lifeline through grants, loans, tax relief or employment support schemes.
Until just a few years ago, investors viewed environmental, social and governance factors as a kind of ‘nice to have’ in their analysis of a company’s prospects. That has changed more recently as the belief has taken hold that sustainability factors might have a material impact on a business’s long-term profitability and, so, investors’ returns. But it has taken the pandemic to provide the first real evidence that a company’s sustainability characteristics could be a proxy for the overall quality of the business and its desirability within an investment portfolio.
In just over a month between mid-February and late-March, the S&P 500 index fell by 25pc. The fifth of companies rated most highly on environmental, social and governance factors by analysts at Fidelity fell during that period by 23.1pc while the worst-rated on those criteria fell by 34.3pc. Each rating level from A to E was worth 2.8 percentage points of performance on average. The correlation between ESG rating and stock market performance was a straight line.
The high-profile collapse of Wirecard, the German-listed card-processing group at the centre of an apparently massive fraud, provided further evidence of how analysing sustainability can help investors achieve better returns. Wirecard was rated E months before the scandal broke. It was clear that it had a problem corporate culture, its management of ethical risks was inadequate and its boardroom governance sub-standard.
Once a month since the pandemic began, we have asked our analysts what they are hearing from the companies they follow. Part of that survey focuses on sustainability issues and, again, the findings have challenged the cynical view that in a time of crisis companies will revert to thinking exclusively about the bottom line.
Actually, more than half of the companies questioned said they intended to step up their focus on workers, consumers and their impact on society in response to Covid-19. Again, it is not a luxury that only the more affluent developed world believes it can afford. Emerging markets in Europe, Africa and Latin America and in Asia, outside China and Japan, saw the biggest swing towards a social focus in the latest survey. Many of the changes look likely to remain in place. Two thirds of companies said new measures they are taking will be permanent.
Investors have a key role to play in this process. There is obviously an element of self-interest here. During the early stages of the pandemic, when markets were falling, there were significant net outflows from investment funds but those with a focus on sustainability bucked this trend, continuing to see steady inflows through the volatility. End investor demand is a key driver.
But there is more to it than this. Big institutional investors understand that active engagement with the companies they invest in is both part of their social purpose and a way to help their clients achieve better financial returns in the long run. They can do this by ongoing dialogue with management, or by using their votes to effect positive change. Ultimately, this is almost certainly a better solution than simply taking capital away from businesses that don’t ‘get it’.
Capitalism is the least-worst way of managing the global economy, but it has to adapt if it is to remain the system of choice. The pandemic will change the world in many ways. It would be great if one of its achievements was to turn Sustainable Investing into plain simple Investing.
