The global pandemic has impacted all of us on a deeply personal level. It has wreaked havoc on our society and our economy, destroying demand and bringing much commerce to a virtual standstill. Just as physical distancing and video meetings are the new normal for social activity, volatility and uncertainty are the new normal for markets.
Fundamentally, we are dealing with a crisis of public health – a crisis for people. For long-term investors, this raises questions about the steps that companies are taking to keep their people safe, well and employed. After all, companies are made of people, and the most resilient companies will be the ones that protect and retain their talent to position themselves for success when the recovery begins.
The pandemic is having myriad impacts on markets, including the market for responsible investments (RI) that incorporate environmental, social and governance (ESG) factors. Here are four market trends to watch at the nexus of ESG and COVID-19.
‘S’ is moving to the forefront
As Benjamin Franklin once said, “It takes many good deeds to build a good reputation, and only one bad one to lose it.” Given the people-focused nature of this crisis, corporate reputations could thrive or plummet based on how companies treat their people and communities. Research shows that over 80% of market value is based on intangible assets, such as brand and reputation. In the COVID-19 era, this puts a spotlight on the ‘S’ in ESG.
In past crises, employees have often been viewed as disposable resources. But in the age of social media, ESG disclosures and CEOs denouncing shareholder primacy, it is less acceptable for a public company to build a margin strategy based on layoffs. Over 330 institutional investors managing north of US$9.5 trillion in assets have made this clear in a public statement on how companies are responding to the pandemic. Capital allocators are asking companies to take every measure possible to retain workers, since unbridled unemployment will only deepen the crisis.
Employee health and safety, including mental wellness, are also moving front and centre. Flexibility has become essential for childcare considerations. So, while social factors had previously been overshadowed by climate change in the ESG space, they are now moving to the forefront as companies will be remembered for how they treated their people and the communities in which they operate.
Investors and consumers can track the good deeds being done by Canadian companies in a new database curated by Canadian Business for Social Responsibility and Upswing Solutions.
In addition, racial discrimination has become highly visible in recent months as citizen journalists share videos of violence and brutality against Black and Indigenous communities, often at the hands of police officers. But racial injustice extends far beyond violence and law enforcement. Nonviolent forms of racial discrimination and inequity are present in many aspects of society, including the companies in which we invest, further emphasizing the importance of social issues in responsible investment. Learn more about the role that investors can play in advancing diversity and inclusion here.
ESG is delivering alpha
The pandemic’s economic impacts have been enormous. Though equity markets collapsed in Q1 2020, they bounced back in Q2. After the explosion of ESG in 2019, driven by the idea that ESG factors are material, it’s only natural for investors to wonder how responsible investments are performing relative to the broader market in 2020.
In the Canadian market, the data for Q1 2020 indicate that RI funds lost less than their counterparts in the market downturn, which further strengthens the case for incorporating ESG issues into investment decisions. According to data provided by Fundata, a staggering 83% of RI funds outperformed their average asset class return in Q1, and 80% of RI funds outperformed over the one-year period ending March 31, 2020. As the market rebounded in Q2, RI funds still held up well relative to their conventional fund peers: 60% of Canadian RI funds out-performed their average asset class return in the three-month period, with more than 86% of RI funds outperforming over the one-year period ending June 30, 2020.
Similarly, in the U.S. market, a Morningstar analysis found that 72% of RI equity funds ranked in the top half of their category in Q2 and all 26 RI equity index funds outperformed their respective conventional index fund peer.
The evidence suggests that ESG factors are delivering alpha in both active and passive strategies. In the pandemic context, this data supports the argument that incorporating ESG issues into investment decisions can strengthen risk management and lead to financial outperformance.
Assets are still flowing into ESG funds
Jon Hale, Morningstar’s head of sustainability research, recently analyzed flows into mutual funds and ETFs in the U.S. market. Despite the downturn, the data shows that RI funds set a record for inbound flows in Q1. The 314 RI funds in the U.S. market attracted net flows of approximately US$10.5 billion in Q1, surpassing the previous record set in Q4 of last year. Research from Morgan Stanley and Bloomberg found similar trends.
We’re seeing a similar pattern in Canada, with Q1 inflows into responsible investment funds outpacing the whole of 2019. Net in-flows into ESG-focused ETFs rose to $740 million, significantly outpacing the $142 million invested in 2019. The available data illustrates that investors remain interested in ESG funds, and perhaps even more so in the pandemic context, which is creating a sense of urgency around societal issues.
Impact investment opportunities are on the rise
The pandemic is shining a light on impact investments, as unique opportunities emerge for investors to help address the crisis by allocating capital to organizations that are helping those most affected by COVID-19. For example, the U.S.-based ImpactAssets runs a donor-advised fund (DAF) that provides financing for fledgling social enterprises and nonprofits in need during the economic downturn. The firm estimates it will see more than US$143 million invested through its DAF by the end of Q2 — more than the total for all of 2019.
Here in Canada, Vancity was first out of the gate with a new product that enables retail investors to directly support those most impacted by COVID-19. The B.C.-based credit union launched its Vancity Unity Term Deposit on March 23rd “to maximize the financial help available to people so they can get back on their feet” during this time of financial hardship. Investors benefit from a fixed rate of return while helping to address the pandemic’s negative social consequences in their community.
These market signals indicate that impact investment opportunities are on the rise as investors seek to help their communities through the crisis.
The evidence suggests that COVID-19 has strengthened the case for incorporating ESG factors into investment decisions, and that the general market movement towards ESG will not be hindered by this downturn. Rather, this crisis is likely to accelerate the adoption of ESG and impact strategies as societal issues move to the forefront and investors feel a greater sense of urgency to make an impact and align their investments with societal objectives.