In a rapidly changing world, companies that are able to anticipate and adapt to new conditions and environments are likely to be more resilient and better positioned to navigate the emerging challenges these new conditions create.

Companies’ adaptability is rooted in their innovation, but innovation is a difficult quality to assess.[1] Yet there are proxies that can indicate a companies’ ability to foster innovation.

MSCI ESG Research looked at the role that talent management practices might play in promoting innovation and setting companies apart.[2] We found that global companies recognized as innovators[3] were leaders in specific areas of talent management practices, including diversity. The recognized innovators had more gender diverse boards of directors on average than their industry peers and were almost twice as likely to have had a persistent critical mass of at least three female directors for three years running.[4] According to the report “diversity may reflect a culture that is open minded and comfortable with differences, focused on accessing and retaining the best talent available, and eager to cultivate creativity and diversity of ideas.”[5]

The problem is not enough companies seem to be taking advantage of the existing, diverse talent pools in their regions. MSCI ESG Research examined ZIP-code-level demographic data to better assess the talent pool available in US companies’ commutable zones for a report called Racial Diversity & Talent Utilization.[6] The report compared US companies’ voluntary employee racial data against their region’s demographic data. And found that often, companies employed lower rates of minorities than were available to them: only 55% employed Blacks and Latinos at rates proportional to their representation in the communities the companies operated.[7] The percentage of companies that proportionally promoted Blacks and Latinos to management positions was even lower: only 14.3%.[8] This underutilization of talent could prevent companies from unlocking innovation capabilities and increasing the overall qualification of their workforce, senior managers and board of directors.

While our research on racial diversity was limited by companies’ disclosures[9], we have conducted extensive research on gender diversity and its benefits. For instance, in the Women on Boards 2019 Progress Report we observed that “in emerging markets, female directors and executives were actually more likely than their male counterparts to have financial expertise.”[10]

In Canada, while there have been board gender rebalancing advancements[11], companies have failed to reach gender parity and still fall short with respect to other forms of diversity. Despite Canada’s multiracial and multiethnic population[12], only 34%[13] of Canadian companies in the MSCI ACWI Index (as of Sep. 22, 2020) who are required to disclose diversity statistics and policies under the Canada Business Corporation Act[14] reported having at least one visible minority director. Only 8%[15] of companies disclosed that they had at least one Indigenous director and 8%[16] reported having at least one director with a disability. While 61%[17] reported having at least one visible minority among their senior management, the ratios for Indigenous people and people with a disability in senior management were lower: 8%[18] and 5%[19], respectively.

As companies face complex and unfamiliar challenges ahead – whether caused by a global pandemic or climate change – they will require all the tools at their disposal, including their ability to leverage people’s diversity of expertise, background, experience and perspective to innovate and find new solutions and opportunities. Investors may want to engage with companies to broaden management capabilities and board oversight effectiveness by increasing diversity.

Sources:

[1] Solomon, Brian. May 12, 2015. You’re doing innovation wrong. Forbes; De Jong, Marc, N. Marston, and E. Roth, April 2015. The eight essentials of innovation. McKinsey Quarterly; Hamel, Gary and N. Tennant. April 27, 2015. The 5 requirements of a truly innovative company. Harvard Business Review; Yu, Larry. July 2007. Measuring the culture of innovation. MIT Sloan Management Review.

[2] Eastman, Meggin. T. 2018. The Right Stuff: Talent Management and Innovation Capacity. MSCI ESG Research

[3] By Fast Company, Forbes, the Boston Consulting Group, and/or the MIT Technology Review

[4], [5] Eastman, Meggin. T. 2018. The Right Stuff: Talent Management and Innovation Capacity. MSCI ESG Research

[6], [7], [8], [9] Frazer, David and Mollod, Gillian. 2019. Racial Diversity & Talent Utilization. MSCI ESG Research

[10] Emelianova, Olga. and Milhomem, Christina. 2019. Women on boards 2019 Progress Report.

[11] Ibid. Between 2016 and 2019 there was an increase in the percentage of total director seats held by women among the Canadian constituents of the MSCI ACWI Index (moving from 22.8% in 2016 to 29.1% in 2019).

[12] Canada 2016 Census

[13] In accordance with information available at the companies’ 2020 management proxy form. It includes two REITs, which are not subject to the Canada Business Corporation Act (CBCA) but have reported trustees’ diversity statistics mirroring the CBCA requirements.

[14] An Act to amend the Canada Business Corporations Act, the Canada Cooperatives Act, the Canada Not-for-profit Corporations Act and the Competition Act (S.C. 2018, c. 8)

[15], [16], [17], [18], [19] In accordance with information available at the companies’ 2020 management proxy form. It includes two REITs, which are not subject to the CBCA but have reported trustees’ diversity statistics mirroring the CBCA requirements.

RIA Disclaimer
The views and opinions expressed in this article are solely those of the authors and do not necessarily reflect the view or position of the Responsible Investment Association (RIA). The RIA does not endorse, recommend, or guarantee any of the claims made by the authors. This article is intended as general information and not investment advice. We recommend consulting with a qualified advisor or investment professional prior to making any investment or investment-related decision.

Discussions on environmental, social, and governance (“ESG”) topics are not new to companies in the energy sector. While oil and gas companies may have previously been considered ESG laggards, this perception has changed over the years; in fact, many oil and gas companies were the first to incorporate ESG metrics in their compensation plans (albeit typically limited to measurable health and safety or operational measures). In December 2018, Royal Dutch Shell PLC (“Shell”), the British-Dutch oil and gas company, went a step beyond health and safety compliance when it announced it would incorporate carbon reduction metrics into its executive incentive plan.

This article examines the process Shell undertook in implementing these metrics, and the role shareholders played throughout.

Shell’s Carbon Reduction Goals & Executive Compensation Timeline
Source: Hugessen Consulting

As illustrated by the timeline, Shell engaged with shareholders throughout the process of establishing carbon goals and incorporating those goals into the executive incentive plans. Although some shareholder resolutions received relatively low support (~5%), they still put the pressure on Shell by emphasizing their focus on ESG.

The response following Shell’s announcement that it would incorporate ESG metrics into incentive plans was somewhat surprising: ShareAction, a registered charity that promotes responsible investment, recommended voting against Shell’s compensation plan. This recommendation was driven by the fact that Shell’s 10% climate measure is outweighed in the Company’s compensation program by volume growth measures, which are achieved by increased fossil fuel output. While the introduction of a climate measure was a positive signal to shareholders, ShareAction argued that ultimately executives are still incentivized to “chase higher levels of … output” to the detriment of the climate and Shell’s long-term value. While it may initially appear as though the shareholder community was criticizing the very plan it had requested, in fact it was critiquing the effectiveness of the stated metrics. Given the media coverage of Shell’s initial announcement, it is no surprise that shareholders continued to follow the story closely and took this opportunity to signal their expectations to the market.

Shell’s approach to tying carbon reduction to executive compensation may still be a work in progress, but it has had a trickle-down effect throughout the oil and gas industry:

• In February 2019, Chevron announced that its goal of reducing methane and flaring intensity by 25-30% by 2023 (relative to 2016 levels) would be incorporated in an incentive scorecard for 45,000 employees.[1]
• In March 2020, BP announced that it would draft a shareholder resolution[2], committing to reach carbon neutrality by 2050.[3]
• In August 2020, Husky Energy announced it would tie executive compensation to a 25% reduction of GHG emissions intensity by 2023.[4]

We expect that shareholders will be energized by these examples of “first movers,” and will continue to put forward resolutions and engage with companies on ESG topics. Furthermore, while not publicly disclosed, we recognize that these case studies appear at almost every industry boardroom table and are top of mind for companies when they consider implementation in their organization.

Although ESG metrics have become more prevalent in compensation plans over the past few years,[5] there will surely be bumps in the road as companies attempt to answer the questions that come with the development of any performance-based compensation program: What metrics make sense? What is the appropriate weighting? Should they be part of the short-term or long-term compensation program? What should the leverage opportunity look like – and what happens if the goal is not met? Shell was one of the first to tackle these questions under the watchful gaze of its shareholders and the broader investor community. We expect more examples to be disclosed in the near term; in particular, we will see how shareholders react to new ESG measures and their view of alignment with performance, integration with the company’s corporate strategy, and the degree of transparency in the short-term and long-term metrics. There will certainly be more learnings to come from each company’s unique path in incorporating ESG metrics in their executive compensation programs.

Article Sources:

[1] Reuters: “Chevron ties executive pay to methane and flaring reduction targets”

[2] The resolution was developed in partnership with Follow This, and is intended to be presented at the FY2020 AGM

[3] Wall Street Journal: “BP Agrees to Draft Climate Change Shareholder Resolution”

[4] CBC: “Canadian oil giants emphasize climate change and diversity as they compete for investment”

[5] Hugessen Consulting: “Integrating ESG considerations into Executive Compensation Governance”

Timeline Sources:

• Hugessen Consulting: “News Flash: Royal Dutch Shell to Introduce Carbon Reduction Metrics in its Executive Compensation Program”
• Royal Dutch Shell FY2019 Annual Report
• ShareAction: “Shell’s and BP’s 2020 remuneration policies”
• Royal Dutch Shell FY2020 Notice of AGM
• Royal Dutch Shell 2020 AGM Voting Results

2020 feels different. Year over year responsible investing (RI) has gained momentum, but 2020 feels like a tipping point. It feels like the notion of “tipping point” has been used countless times to describe the state of the market, but 2020 feels different than other years.

The COVID-19 pandemic has devastated society and the economy as we know it, creating the “perfect storm” of environmental, social and governance (ESG) issues. This has accelerated both the need and importance for investors to take action. As we look forward to an economic recovery, we need to not only think about how to rebuild, but how to rebuild better.

Resilience Rules

The COVID-19 pandemic has provided the world with an opportunity to pause and an opportunity for investors to reflect on RI’s path forward. Undoubtedly, the stakes have changed over the past 6 months. The term “resilience” comes to mind when describing what investors should look for as they assess the ESG factors associated with investee companies – the capacity to recover quickly following difficulties and the ability to adapt – a fitting term for the current times.

The examination of ESG factors (particularly “E”) has historically focused on compliance and efficiency. While these are in their own right important concepts, there is a sense now that it isn’t good enough for companies to reduce costs through maximizing efficiency or to simply operate within the confines of their legal license to operate. Instead, the narrative of “building back better” will drive a shift in thinking towards resiliency and purpose. Take the oil and gas industry as an example.

There is little doubt of the impact that companies in this industry are facing and will continue to face going forward. Growth in renewable energy technologies continues to be strong, leading to a decline in prices. At the same time, the pandemic has very likely had a permanent impact on the demand for fossil fuels, meaning we may have seen peak demand for fossil fuels come and go in 2019.[1] The result is an altered supply and demand dynamic for oil and gas companies to grapple with. Mix in a commitment by the Canadian government to legislate net zero emissions by 2050 and to set more ambitious 2030 emissions targets (with a touch of more stringent regulation of course), and you get a scenario where the oil and gas industry needs to step up.[2] The good news is that this is already happening. However, while some of the largest players have made significant progress in improving their efficiency, they are now focused on positioning themselves at the forefront of the transition to a low carbon economy, including ambitious targets to cut oil and gas production and major organizational restructuring – a clear shift from efficiency to resiliency.[3]

Continuing with this train of thought, the most significant issues that we are facing today, including the climate crisis, systemic racism and the COVID-19 recovery process will not only require companies to become more resilient, but that they operate in a manner that is positively impacting the environment and society. For investors, it will be imperative to invest in companies who are on the right side of change, and not on the wrong side of it. These companies are not only resilient but will also be well positioned to meet changing consumer expectations and preferences. If investors do this, they can achieve the popular goal of “doing well by doing good”.

The Importance of Impact Investing – the “New” Kid on the Block?

Change, by definition, is difficult. As outlined in a recent report published by the Future Fit Foundation, our economy is not currently built to accommodate the concept of “purpose”.[4] Perhaps this is best captured in a quote by environmentalist Paul Hawken:

“We have an economy where we steal the future, sell it in the present, and call it GDP.” – Paul Hawken

Enter impact investing. As investors, we have the opportunity to allocate capital towards businesses that are demonstrating resilience and purpose; who are positioned to do well by doing good through achieving strong financial returns while positively impacting the environment and society. Investing with impact in mind will be a key concept for ensuring that the environment, society, businesses and our economy flourish. While impact investing isn’t without its challenges, such as defining and measuring impact, this is no reason to avoid it. Fortunately, the United Nations Sustainable Development Goals (UN SDGs) provide a holistic framework that can be leveraged by companies and investors to map their activities to areas that address global systemic challenges including climate change, inequality and poverty. These goals may have never been more important than they are today.

As an asset manager, we have been thinking quite a bit about impact investing and the SDGs, leading to the development and launch of the CI MSCI World ESG Impact ETF and the CI MSCI World ESG Impact Fund last year. Investing in companies that are contributing to positive environmental and social impact is increasingly becoming commonplace for investors that incorporate ESG factors into their investment decision-making process. This trend is likely to continue (and accelerate) as we enter a COVID-19 recovery process and continue to feel the impacts of systemic issues like racism and climate change. The transformation of RI into just “investing” has been a topic of debate in recent memory. With current events sparking a change in the way in which investors think about and approach RI, 2020 could be remembered as a year where we take a big step forward in the evolution of RI. While impact investing is certainly not a new concept, it’s positioned now to be the “new” kid on the block – the “new” RI.

Sources:

[1] https://carbontracker.org/peak-fossil-fuels-new-grounds-for-hope/

[2] https://www.canada.ca/en/privy-council/campaigns/speech-throne/2020/stronger-resilient-canada.html

[3] https://www.responsible-investor.com/articles/what-can-investors-learn-from-the-covid-19-pandemic

[4] https://futurefitbusiness.org/wp-content/uploads/2020/07/Future-Fit-Business-Beyond-COVID-19.pdf

RIA Disclaimer
The views and opinions expressed in this article are solely those of the authors and do not necessarily reflect the view or position of the Responsible Investment Association (RIA). The RIA does not endorse, recommend, or guarantee any of the claims made by the authors. This article is intended as general information and not investment advice. We recommend consulting with a qualified advisor or investment professional prior to making any investment or investment-related decision.

According to the Global Sustainable Investment Alliance (GSIA), professionally-managed assets labeled as “ESG” or “sustainable” accounted for over 30 trillion globally at the start of 2018. As of that same year, they represented more than 50% of all professionally-managed assets in Canada, Australia, and New Zealand, respectively.

As AUM of professionally-managed ESG assets continues to grow and more firms consider how to incorporate it into their everyday processes, they are faced with the challenge of determining which sources of ESG information best align with their investment approach and workflows. The rise of ESG-related financial regulatory initiatives is another ongoing challenge as companies are forced to continually reassess their compliance strategies. Regardless of firm type, size, and mandate, selecting ESG data is especially difficult because it is a nuanced and evolving space that does not have a single, definitive set of standards for how and what information should be measured and reported.[1]

Some of an investor’s customization needs can be met by a singular vendor that supplies ESG ratings. Others want to create custom scores by combining and aggregating several datasets. We can categorize these approaches into the following buckets:

• Buy: Purchase one or more datasets that include pre-calculated ESG scores. Investors may use the top-level ESG score provided for each company or customize their analysis by aggregating the underlying category-level scores supplied by the vendor.
• Build: Create a custom measure for ESG performance rather than using pre-calculated ESG scores. This will require additional resources and granular metrics on specific ESG issues such as governance practices and environmental impacts. Building a proprietary ESG score will guarantee the investor has full transparency into the calculation and can tailor the methodology to meet their needs.
• Blend: Customize ESG analysis and create a custom measure by combining multiple ESG datasets with different attributes and data items. This approach falls between the two preceding buckets in that it requires fewer resources than build and offers a greater level of customization than buy. An example would be using a dataset that has aggregated ESG scores across a breadth of issues in conjunction with a provider who offers detailed carbon emissions data.

The decision to use the buy, build, or blend approach is often influenced by the resources committed to implementing ESG strategies and the scale of the project at the hand. These resources can include budget, team size, and experience working with ESG data. The scale of the project refers to whether an investor is rolling out one ESG portfolio or creating an entire suite of ESG products as well as whether the team is looking to monetize a custom ESG score.

By understanding the firm’s needs, investors can efficiently narrow their focus to vendors that meet their criteria. While investors’ specific data requirements will vary, two concerns are relevant to all ESG integrations:

1. ESG regulations will undoubtedly continue to evolve and influence how ESG information is incorporated and evaluated
   While the EU leads the way with a comprehensive ESG regulatory framework, this will eventually impact other regions as well. New regulations will require data providers to adapt their methodology; they will also likely require investors to re-evaluate their data integration, portfolio mandates, and reporting capabilities. As a result, investors must bring inquisitiveness into the data selection process to understand where they fall in the considerations we discussed above. They will also need to look into how vendors will adapt to regulations in the future so that they (and their clients) can have a better understanding of what’s to come.
2. ESG data is not evaluated in isolation and will need to be connected to other content in the investment process
   The backbone of that connectivity is a reliable symbology model. Even the most insightful ESG data is useless without a consistent set of permanent identifiers to ensure that data from different content sets are linked to the same securities over time. This is easier said than done for many firms as vendors often employ proprietary company identifiers, requiring investors to learn and connect multiple symbology models.

While the AUM of professionally-managed ESG assets continues to grow and more investors enter the ESG space, their time should not be spent struggling to navigate the landscape of ESG data providers.

The framework established above is intended to simplify this landscape and highlight the importance of understanding key differentiators between ESG products. If followed correctly, it can be extremely useful in drawing connections between key internal considerations and specific vendors on the market. The more time investment firms spend on assessing their own needs and taking the steps required to fulfill them, the more confident they can be when framing vendor discussions and selecting an ESG provider.

Sources:

^[1] https://advantage.factset.com/solving-the-esg-data-challenge

RIA Disclaimer
The views and opinions expressed in this article are solely those of the authors and do not necessarily reflect the view or position of the Responsible Investment Association (RIA). The RIA does not endorse, recommend, or guarantee any of the claims made by the authors. This article is intended as general information and not investment advice. We recommend consulting with a qualified advisor or investment professional prior to making any investment or investment-related decision.

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.

Conclusion

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.

This article was originally published in Investment Executive and has been republished with permission.

COVID-19 has left investors in the animal protein sector not only worried about a short-term economic shock, but also the long-term systemic risks rooted in the industry’s supply chains.

The last few months have put the global meat and dairy sector at the centre of the coronavirus outbreak and the repercussions have hit the sector hard.

In the US, thousands of meat-packing plants have been forced to drastically reduce output with over 20,000 workers contracting the virus to date. Despite this, most plants controversially remain open due to an Executive Order from the President signed into law in April. The supply chain disruption has caused bottlenecks with many animal producers forced to cull a huge backlog of livestock. At least two million animals were reportedly culled on farms in the US within the first six weeks of the pandemic.

The financial fallout of this is expected to be felt by the livestock sector for a long time to come, with current industry experts predicting losses of around $20 billion for this year alone. The head of commodities at Goldman Sachs has listed livestock alongside oil as one of the two most precarious commodities for investors next year.

Avoiding the next pandemic

One of the key problems for the industry is that the factory farming model is not only vulnerable to pandemics, it is woefully unprepared to mitigate the risk of future zoonotic diseases. Indeed, current practice is shown to actually facilitate the emergence of possible future pandemics. Large numbers of animals crammed together into confined spaces, combined with unsanitary working conditions, overuse of antibiotics and sprawling global supply chains all create the ideal conditions for new zoonotic diseases to emerge and spread.

Three in four emerging infectious diseases in humans are, like COVID-19, zoonotic (i.e. they are transferred between animals and humans). Despite this, a recent report by FAIRR, entitled ‘An Industry Infected’, showed that over 70% of the meat, fish and dairy companies assessed were ill equipped to deal with a future pandemic.

And disease risk is just the latest in a long line of risk factors involved in intensive animal protein production. High emissions and water usage continue to cause concern amongst both consumers and investors, with the regulatory risks and costs of dealing with these issues likely to stack up for the meat industry in the years to come.

Alternatives rising

Against this backdrop of empty meat shelves and heightened health concerns, plant-based meat alternatives have benefitted from a boost in consumer sales during the current pandemic. Plant-based sales have rocketed in recent months, rising by nearly 200% in April compared to 2019.

This spells opportunity for meat firms such as Canada’s Maple Leaf Foods. Analysis of 60 global meat, fish and dairy firms by the Coller FAIRR Protein Producer Index found that Maple Leaf was leading its peers when it comes to diversifying into alternative proteins, and is currently the only meat producer to disclose sales from plant proteins, reporting 4.3% of total sales from its plant protein segment in Q3 2019.

The competition from plant-based proteins is hard to ignore; they are more efficient to produce, need less water and produce less greenhouse gas emissions per calorie of protein than meat. They also come without the dangerous zoonotic disease risks associated with livestock. Consumer willingness to buy alternative products appears to have transitioned from a “one off” event to a more permanent consumer purchasing habit. Growing public consciousness around the link between zoonotic disease and intensive animal agriculture, as well as the heavy environmental toll of meat production, indicates this transition to plant-based proteins is only set to increase in the future.

Costly and complex regulation

Meanwhile, animal protein producers are likely to be forced to instigate a number of disruptive measures to stop the outbreak of zoonotic pandemics becoming ‘the new normal’. An announcement in Germany in May 2020 indicated regulators will demand higher hygiene standards, improved inspection regimes as well as fines for labour rights violations by meat processes. So far, regulatory conversations have focussed on banning live exports, tackling the overuse of antibiotics, standard vaccinations and assurance checks, and implementing moratoriums on factory farms. Given the geographical nuances around regulation, multinational meat giants will need a holistic and strategic approach to meeting standards in order to safeguard global supply chains.

At best, new regulation will prove costly to the meat sector. At worst, meeting best practices will prove fundamentally incompatible with animal agriculture’s business models: the most effective long-term mitigation of pandemic risks will come through diversification into plant-based proteins.

As the world pieces itself back together in the aftermath of COVID-19, investors are already looking to the future. The strains on the meat sector during this time have been telling and perhaps most worryingly, COVID-19 was not the first and – without material changes in the intensive animal agriculture industry – will likely not be the last animal-borne disease outbreak. Investors will be looking at the lessons learned today for any future pandemics to come.

RIA Disclaimer
The views and opinions expressed in this article are solely those of the authors and do not necessarily reflect the view or position of the Responsible Investment Association (RIA). The RIA does not endorse, recommend, or guarantee any of the claims made by the authors. This article is intended as general information and not investment advice. We recommend consulting with a qualified advisor or investment professional prior to making any investment or investment-related decision.

The impact of COVID-19 on the global food chain has been dramatic. Queues at food retailers, short supply of key goods and the difficulties of shopping while physical distancing have impacted a vast swathe of the global population. In production – specifically in meat processing plants – the lack of distancing options or virus appropriate protection gear has seen many workers fall ill and plants closing. Meanwhile, with the commercial supply chain coming to a halt, we have also seen a rise in food waste.

Impacts to food supply

As with many other supply chains, food systems are complex and global, and are currently experiencing a combination of disruptions:

• Harvest disruption: It is harvest season in many regions of the northern hemisphere. This theoretically secures food availability locally for the duration of the season. Agriculture hugely relies on cheap but experienced and flexible labourers. With borders closed, low-wage labour – for example from Central and Eastern Europe, or South America (also largely in lockdown) for their richer neighbours – has become scarce. Despite quickly developed exemptions, such as specific visa programs, many farmers fear large parts of their crops going to waste.
• Production disruption: Production has been completely halted in various sites across the world due to virus outbreaks among staff and difficulties implementing physical distancing. Examples include pork processing and meat packaging plants, such as those owned by US producers Smithfield and Tyson. For others, production might be halted over a lack of ingredients.
• Transport and trade disruptions: Some ports are not operating as usual, and shipping may be delayed or cancelled. Freight trains or trucks may not cross borders, and some countries have stopped all flights.
• Export restrictions: Even if transport is still allowed, export restrictions might disrupt delivery. Turkey, responsible for one third of the global lemon supply, has limited export of the product. Russia, Ukraine and Romania are among those halting grain exports. While currently these restrictions are still exceptions, their impact is still being felt. The reduction in grain exports is impacting livestock farmers, with some already struggling to find enough feed for their herds.^[1]
• Switch from commercial to retail demand: Patterns of food consumption have changed dramatically as people eat at home rather than at work or in restaurants, meaning that food demand has suddenly switched from commercial to retail. But retail and commercial supply chains fundamentally differ in terms of the quantities, sizes, formats of delivery and packaging, as well as ordering mechanisms. This has led to loss of income and food waste.

The most critical impacts of a failure to address these challenges will be felt in the world’s poorest countries. The UN’s World Food Program highlighted^[2] that the number suffering from hunger due to the COVID-19 crisis could go from 135 million to more than 250 million, with least developed nations most affected^[3] – increasing the human impact of this pandemic beyond those immediately affected by the virus, and presenting a serious threat to the achievement of SDG 2: Zero Hunger. In some agricultural regions, droughts and plagues of locusts add further complexity.

Engagement

Investor engagement with retailers, traders, and producers around sustainable food systems is one part of solving the problem. The pandemic reinforces the case for supply chain stress testing, effective business continuity plans, and for strong relationships with suppliers rather than relying on third parties. Some companies have recognized the financial strain their suppliers are under and have paid invoices early or supported loan guarantee programs.

A key focus area is worker protection. The food chain is labour-intensive, and characterized by badly paid, often physically demanding jobs. Engagement must address and investigate the additional challenges that the pandemic has brought, such as the difficulties in implementing physical distancing in environments such as factories and food stores. Where good practices have emerged, such as paid sick leave, engagement should encourage these to be made permanent.

Further engagement options include encouraging financial institutions to support their commercial clients in the food business, including grants, mortgage holidays and debt relief discussions. Sovereign debt engagement could feature discussions around minimization of restrictions on export and trade, as well as on responsible stockpiling.

Conclusion

The task of ensuring food security and business continuity is complex, with challenges including protecting workers, shifting supply chains from commercial to retail, and financially supporting farmers and related industry actors.

Investor engagement is only one small part of the solution but given the scale of the issue, it is important. Investors are not purely financial, but also social actors with a corporate responsibility. To address hunger, debt relief programs implemented by the G20 will need a capital markets’ replication. In line with the call by the G20^[4], private creditors need to “explore the options for the suspension of debt service payments”^[5] to relieve some of the poorest nations of their immediate repayment requirements so they can focus on securing and distributing food for their populations.

Sources:

[1] https://www.bloomberg.com/news/articles/2020-04-10/food-supply-fears-are-growing-as-romania-bans-grain-exports

[2] 2020 – Report on Global Food Crises https://www.wfp.org/publications/2020-global-report-food-crises

[3] The countries most affected are likely Yemen, the Democratic Republic of the Congo, Afghanistan, Venezuela, Ethiopia, South Sudan, Sudan, Syria, Nigeria and Haiti.

[4] Private sector should join poor countries’ debt relief plan, FT, May 2020: https://www.ft.com/content/f4de06d4-8af3-11ea-a109-483c62d17528

[5] G20 Communique of Finance Ministers and Central Bank Governors Meeting, April 2020

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RIA Disclaimer
The views and opinions expressed in this article are solely those of the authors and do not necessarily reflect the view or position of the Responsible Investment Association (RIA). The RIA does not endorse, recommend, or guarantee any of the claims made by the authors. This article is intended as general information and not investment advice. We recommend consulting with a qualified advisor or investment professional prior to making any investment or investment-related decision.

The COVID-19 pandemic and social turmoil evidenced this year in the United States and beyond has, like nothing before it, thrown into stark relief why ESG matters for investors.

Their response and that of their portfolio companies to these unprecedented and seismic events may well define the next generation of investing. What are institutions now doing to address these challenges and how is the ESG data, ratings, and research industry responding to meet those needs? And how will institutions cater to the burgeoning millennial and other important demographics whose views are now being forged in the crucible of the events of 2020? This Q&A with Marija Kramer, Head of ISS ESG, the responsible investment arm of investment adviser Institutional Shareholder Services, will explore these and other pressing questions.

What in your estimation is proof that the COVID-19 pandemic has accelerated the shift toward ESG?

Pundits early in the pandemic predicted one of its consequences would be a greater focus by investors on company fundamentals to the detriment of ESG and other extra-financial considerations. In fact, the opposite has transpired. Anecdotally, we’ve had numerous conversations with clients and other stakeholders asking how they can further integrate ESG considerations into their current investment-decision making processes. They want to ensure their portfolios are weighted toward companies with a long-term focus and are proving more capable of weathering this storm than peers managing quarter-to-quarter. Empirically, our analysts have highlighted ESG outperformance since the pandemic and, finally, we have seen a record 18 majority votes on environmental and social shareholder proposals during the U.S. annual meeting season, compared with the previous high-water mark of 12 in calendar 2019. Collectively, this represents to me clear evidence that ESG is gaining greater currency as a result of the pandemic.

How will the pandemic affect corporate disclosures if, as you note, their shareholder will be focused more sharply on ESG?

Many across the industry have been waiting for movement or some inkling of progress from regulatory bodies on the need to mandate and harmonize corporate ESG disclosures. It’s no doubt tricky; the “E” is far more critical for certain sectors while the “S” is for others. But getting back to the pandemic, what we have seen is what I would argue was unprecedented nimbleness on the part of regulators to issue guidance relative to COVID-19 on matters ranging from liquidity disclosures to employee health and safety. This same level of responsiveness can translate into accelerated action by regulatory bodies on ESG disclosures if the will is there. And as ESG grows in importance, that will arrive sooner rather than later.

Social unrest in the U.S. and beyond has changed the calculus for some mainstream investment fund complexes. How are investors now seeing the issue of race and how will those changing views affect their investment decisions in the months and years to come?

Institutional investors are as conscious of what is happening on the streets of major U.S. cities as any other group. Much as we have seen in recent years investors focus on board gender and skills diversity, I predict we will similarly see them step into this area to help fill the regulatory void and appeal to a younger and more socially conscious demographic. I expect ratings, research, and data providers will step in to fill the current void for insight in this area, including through relevant indices and screens for passive and active investors alike. Here, I would like to see ISS ESG lead the way and expect it will.

What are you seeing and hearing from clients with regard to their need for data and analytics as it pertains to climate and how has this changed pre-pandemic compared with today?

The world is getting a crash course in systemic thinking and what it means for a systemic crisis to unfold globally. Investors are very aware that climate change challenges have very similar characteristics to COVID, namely that science is clearly predicting it as a central risk in the future; the inability to self-isolate as it spans the globe and the delay between our actions and when risks materialize. Throughout the coronavirus crisis, we have seen a strong continued interest in the topic of climate, and I think a better understanding of how to think about crisis situations and fat-tail events, i.e. shocks that have low probability but high impact, will influence thinking for years to come. My impression is that the silver lining COVID provided investors is the evidence that when a threat is imminent enough, stakeholders—including investors—can directly make an impact.

How likely is it that the COVID-spurred reduced use of fossil fuels will have a lasting impact on efforts to combat climate change?

The pandemic has indeed led to a reduction of emissions; according to initial studies, emissions were down 8.6 percent in the first four months of the year compared with 2019 levels. Short-term, that is great. But at the same time, it shows us that the link between economic activity and emissions continues to be highly relevant and which ultimately needs to be broken by decoupling economic growth from emissions. Climate change is a long-term challenge and, in the larger scheme of things, one year of low emissions will not make a material difference. However, institutional investors can use the current situation to help effect change with portfolio companies and, by extension, alter the underlying structure of the economy. What will be key as we look ahead is therefore to ensure green recovery plans.

What in your view is notable about sustainable bonds on the heels of COVID-19?

There has indeed been market interest in sustainable bonds in the context of the coronavirus crisis and sustainable bonds have yet again shown that they can adapt to an emerging challenge at hand. The biggest shift in the context of COVID-19 is that social bonds (dubbed COVID-19 bonds and issued to, for example, support employment and medical infrastructure) have gained prominence. What will be interesting to see in the future is to which extent green bonds will be used as an instrument to finance a green recovery.

RIA Disclaimer
The views and opinions expressed in this article are solely those of the authors and do not necessarily reflect the view or position of the Responsible Investment Association (RIA). The RIA does not endorse, recommend, or guarantee any of the claims made by the authors. This article is intended as general information and not investment advice. We recommend consulting with a qualified advisor or investment professional prior to making any investment or investment-related decision.

From Facebook’s data breach to the Vale Dam disaster to Volkswagen’s emissions scandal, we have seen how an environmental, social or governance (ESG) issue, especially when overlooked, can eventually surface and have a tremendous impact on a company’s performance.

It has become clear that the world has less tolerance for bad behaviour and investors are on the hunt for strategies that do well while doing good. While ESG considerations have become applied by some mainstream investors, the alternative fund management industry has been slower to adopt it and the focus has mostly been on SRI and impact funds. But changes in the way hedge funds evaluate companies are underway.

When we originally started our ESG learning journey we thought we could simply buy third party data and incorporate them into our fundamental work; however, we quickly discovered what we believe are the short comings of ESG rating agencies. For example, data providers often use static, backward looking and voluntary company disclosures. This led us to develop our own proprietary scoring framework.

Our 30 factor framework was developed based on SASB materiality research, the U.N. Sustainable Development Goals, third-party studies and our own subjective criteria. The factors are consistent across sectors; however, the “E”, “S”, and “G” are weighted differently across sectors. For example, in energy and mining the “E” is more relevant, whereas in consumer products such as, tobacco producers the “S” is more relevant. There are 11 global industry classification standards (“GICS”) sectors, so we started with 11 different scorecards and continued to refine sub-sector scorecards from there. This allows us to not only identify companies with positive ESG scores and practices, but also effectively short the bad actors.

By examining the case of an International Cruise Line stock (“Company X”), we will demonstrate the following:

• How a failure to comply with ESG will eventually cause a material valuation impact
• How hedge funds can incorporate ESG into their valuations and use a long/short approach to reward the “good” companies and short the “bad actors”.

In the case of Company X, one of the largest players in the global cruising industry, we saw the looming impact on its valuation through operational, reputational, and regulatory disruptions as well as incremental operating costs and capital expenditures.

Company X holds 40% of the global market and is facing rising environmental headwinds, including stricter regulations from organizations such as the International Maritime Organisation (IMO) 2020, which ruled that as of January 1, 2020, marine sector emissions in international waters must be cut. In 2019, a study found that the air on Company X ships has as much air pollution as the city of Beijing, one of the worst offenders in air quality. The regulatory and investment communities are holding companies to higher standards regarding their environmental and social practices, creating new implications for companies like cruise line stocks.

We look at multiple third party scores and normalize them within our framework to arrive at a final third party score. In the case of Company X third parties gave them a -0.05 ESG score whereas at Waratah Capital Advisors Ltd., it received a -2.00 score, and a clear short.

Despite heavy negative scrutiny in 2019, including a Federal judge threatening to ban the company from docking at U.S. ports, Company X kicked off 2020 with yet another negative headline in violation of U.S. regulations finding themselves in the spotlight once again for pollution. The Florida Department of Protection confirmed that they discharged approximately 5,900 gallons of “gray water” into the ocean. Gray water is leftover water containing bacteria (among many other dangerous items) from baths, sinks, showers and laundry facilities. Company X is a repeat offender and has skirted environmental regulations 10 times. Although Company X aspires to be the industry leader in best practices and environmental responsibility from a policy perspective, this event clearly indicates that in reality they are not committed to making improvements, and continues to pose a high ESG risk.

With the global macro uncertainty related to the COVID-19 pandemic, cruises are becoming incrementally more of a discretionary item, resulting in pricing softness coupled with endless new industry capacity. On March 8 the CDC issued a public advisory to “defer all cruise ship travel worldwide” yet Company X still had passengers at sea in early April, nearly a month after. The company’s Chief Medical Officer even made early coronavirus warnings; however, Company X continued operations as usual. This gave rise to new lawsuits filed combined with social issues related to their handling of the coronavirus while stranding thousands of guests and workers at sea. More than 1,500 people on the company’s cruise ships were diagnosed with coronavirus and dozens died. As an active manager, Waratah was well aware of the infractions continuing to take place with Company X, so in response to these events, we were able to re-score the company, ultimately lowering it further from -2.00 to -2.25.

Based on our assessment, we noticed a repetitive pattern of Company X attempting to conceal their environmental breaches under probation. This resulted in one of the largest adjustment factors in our internal scoring database. As we continued to monitor Company X, it was noticed that internal governance within the company was not improving, which was evident through continual breaches and controversies. We downgraded Company X further, which has also been strongly correlated with their negative stock performance.

Waratah’s investment thesis was to short the position on behalf of our clients based on ESG risks: environmental concerns and law suits due to the repetitive breach of large legal settlements and poor industry dynamics, which ultimately impacted fundamentals. The scoring decision for our short position of Company X was extremely advantageous. This is evident through their stock performance as the YTD return for the company is -70.88%, which is underperforming the overall stock market by 71.03%.

Specifically within the cruise line industry, companies are susceptible to environmental risks more than ever. We believe that it is important to identify the bad actors in the space early on. With rising awareness of pollution and evolving environmental regulations, there is undoubtedly a higher potential consequence for fines and risk.

Company X is a great ESG short case study where they have been placed on probation and fined $40MN in late 2016. Company X violated their probation repetitively by attempting to falsify records, dump waste into the ocean, and illegally dump gray water off the ships. Resultantly, the court even threatened to restrict their ships from US ports. This had materially impacted their financials, and ultimately played into the growing theme of environmental risks that affect interest from investors and even customers. This shift of ESG narrative from corporates could hopefully push the company to revamp their operations to ensure complete transparent, honest, and environmentally cleaner operations moving forward.

Thankfully, there is a compelling connection between ESG factors, performance and risk, which makes it evident that ESG, is here to stay. Investment managers can achieve meaningful impact as well as meaningful financial returns over the long-term by integrating ESG considerations into fundamental investment analysis and portfolio construction. It is clear that if ESG factors are not considered in fundamental analysis, opportunities and risks are not addressed. A long short approach allows managers to reward the “good” companies and short the bad actors, increasing their cost of capital and using the capital markets to encourage change.

Contributor Disclaimer
Waratah may change its views in the subject companies discussed in this article at any time for any reason and disclaims any obligation to notify any party of such changes.  The information and opinions contained in this article are not and should not be perceived as investment advice or a solicitation to buy or sell securities.  Waratah makes no representation or warranty, express or implied as to the accuracy or completeness of the statements made in this article nor does it undertake to correct, update or revise those statements.

RIA Disclaimer
The views and opinions expressed in this article are solely those of the authors and do not necessarily reflect the view or position of the Responsible Investment Association (RIA). The RIA does not endorse, recommend, or guarantee any of the claims made by the authors. This article is intended as general information and not investment advice. We recommend consulting with a qualified advisor or investment professional prior to making any investment or investment-related decision.

It is clear that the perfect storm created by the breadth, immediacy and severity of the COVID-19 crisis and the collapse in oil prices has created significant uncertainty for investors going forward. Public equity prices seem disconnected with the economic outlook companies face and cannot be completely explained by asset allocation movements due to extremely low yields for the foreseeable future.

As we look to rebuild our economy, what lessons might we as investment managers and advisors learn from the COVID-19 crisis, or indeed the climate crisis and the societal crisis of systemic racism?

Crisis brings reflection, and reminder of fundamentals

As an advisory and investment management firm working exclusively on responsible and impact investing across all asset classes, we took time to reflect and assess our basic assumptions in light of recent events. COVID-19 had already shone a light on cracks in a market system that left many communities excluded from opportunities for economic prosperity, growing income inequality and the disproportionate burden of the virus. The recent deaths of George Floyd, Breonna Taylor and others highlighted again the systemic racism in our societies that handicaps black, racialized and structurally excluded communities. Calls to ‘build back better’ caused us to reflect on what we do and how we contribute to better outcomes through our focus on responsible and impact investing.

Upon reflection, our belief has held firm that market performance over the long term will ultimately be delivered by investing in companies that can deliver stronger financial performance.

Which companies are they, exactly? Those focused in markets and sectors that have better prospects for growth; those building strong sustainable competitive advantages, often referred to as economic moat; those focused on meeting the United Nations’ Sustainable Development Goals, where $2-4 trillion of capital is needed annually; and those with greater resiliency to withstand and absorb shocks, recover and still carry on. These are companies that have invested in building trust, goodwill and shared value with their many stakeholders – employees, suppliers, customers and communities. They embedded resilience in their systems, their operations and even their capital structure, when times were good.

A key role for advisors

As investment managers and investment advisors, most of us are being called upon to reassure and comfort clients; the value of that trusted professional advice in an uncertain world is heightened. A good starting point is reminding clients that investing for the long term is still a sound strategy, but this is not enough. We need to communicate the benefits of investing for impact as a solution.

Specifically:

• Investing in companies which are helping to create a better world through their products or services, and their operations, will enhance the prospects of sound financial returns and avoid unnecessary risk
• There are companies to invest in but it takes effort, research and diligence to separate out those that are genuine from the pretenders
• How and where you allocate your capital is a tool for expressing the values that are important to you, just like where you give, what you support and where and what you buy

Confirmed by recent momentum

Evidence seems to indicate that this shift is already happening and accelerating. When we look at the data from QI 2020, we see two material trends: more capital is flowing to funds that are ESG focused relative to 2019 and there is growing evidence of a positive association between ESG-focused investing and performance. [1] We believe these are long-term secular trends because they are being driven by many underlying shifts and many players in the global markets.

In fact, we expect that, in their quest for sustainable long-term returns, more investors will deepen their focus and move along the continuum from ESG to responsible and ultimately impact investing. That is why we responded to specific client requests and launched two impact funds in June that provide the market with a multi-asset class and a global equities impact investing option*.

The purpose of wealth creation through investing is to deliver prosperity, enjoyment and well-being to clients. We cannot deliver these benefits to these clients if we ignore how the money we invest is used by the companies we invest in. If we are to deal with the crises we face, be it climate change, COVID-19 or systemic racism, we must rebuild better by shifting more money to responsible investing. Now is not the time to change course but to double down – to make sure we are not driven by a desire to relive the past but instead build a better future.

*This does not constitute an offer to sell, a solicitation of an offer to buy, or a recommendation of any security or any other product or service offered by Rally Assets. Rally funds are available to accredited investors only. You should consult your investment advisor or other appropriate professional regarding your specific situation.

Sources:
[1] https://www.morningstar.ca/ca/news/202180/canadian-esg-funds-grew-faster.aspx
https://www.blackrock.com/corporate/about-us/sustainability-resilience-research

RIA Disclaimer
The views and opinions expressed in this article are solely those of the authors and do not necessarily reflect the view or position of the Responsible Investment Association (RIA). The RIA does not endorse, recommend, or guarantee any of the claims made by the authors. This article is intended as general information and not investment advice. We recommend consulting with a qualified advisor or investment professional prior to making any investment or investment-related decision.