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ESG and Firefighting

By: Jack Dominy


When your time is being consumed putting out a spectacular, raging fire, does it make sense to be distracted by another slow burn? Surely your time is best focused on the pressing matter at hand and everything else can wait?

But what if the tactics you have already been using to fight this gradually building blaze could help you contain the more urgent one? Would it make sense then?

In this analogy, the fires refer to the immediate danger of the Covid-19 pandemic and the less rapid, although still pressing, matter of climate change – or more broadly the adaption of environmental, social and governance factors into investment strategies.

While the virus has caused unprecedented damage to society, public health and global finances, it has – perhaps less dramatically – left investors scrambling to protect their portfolios.

Few could have predicted the harm the pandemic, and our global reaction to it, could have had to the economy, nor how long the reparations are going to take. The future is certainly unclear.

What some did foresee, however, was that sustainable investment might be a way to deflect the worst misfortunes any substantial event could impart onto the world, away from long-term returns.

Looking back

ESG had been the recent darling of the investment world. In some circles it was heralded as a panacea that would help investors pick all the winners for their portfolios and kick out the long-term losers. In others, it was even being integrated across investment company policy, such was the drive to embrace a “better” approach to the future.

Indeed, as results from Research in Finance’s inaugural UK Responsible Investing Study (UKRIS) indicate, around four fifths of retail intermediaries have clients with responsible funds, and nearly nine in ten consultants state the pension scheme clients they advise have some sort of responsible funds. Demand for ESG funds (retail) and ESG integration funds (institutional) in particular are set to increase over the next year as well, although there is also appetite for sustainable funds and to some extent, impact funds.

But as often happens, long-term good intentions can be dropped when a short-term crisis arises, or at least be put on the back burner.

However, for those that maintained their ESG stance, there may have been huge rewards.

In the first quarter of 2020, when the first massive shocks to world stock markets were sustained, global ESG funds outperformed the broader market by a little more than 1% on a net basis, according to Refinitiv. Some 54% of ESG funds outpaced their conventional peers, although it is worth noting that the universe of traditional funds has a much larger spread of results due to its size.

There are a myriad of factors behind the outperformance – not insignificantly the massive drop in oil prices that would have barely impacted many ESG-branded funds – but as we advance through what many still believe is the opening remarks of the Covid-19 crisis, it is worth paying attention to the basic elements of ESG and how it could help protect a portfolio.

Behind the acronym

While much focus is put on the separate E, S and G elements of this investment theory, the basic premise is sustainability.

With the regulatory push to reduce carbon emissions, fossil fuel companies are not sustainable; companies that exploit their workforce or surrounding community are not sustainable; companies that cook their books are not sustainable – although a few manage to avoid detection for some time.

Though many of these concerns can take years to come to fruition, a short, sharp shock can throw them into sharp relief.

If the last crisis was a problem of liquidity, this one is an issue of solvency, and sustainability is tied into this inextricably.

Without a detailed business model that takes the ESG elements into account – and not just clinging to one and ignoring the others – companies entering a world where climate change and corporate responsibility are at the forefront of conversations are likely to come unstuck.

That’s not to say that a company sticking to all elements of the ESG dogma will not fail in whatever disaster is scheduled to happen next, it is just less likely to do so than one that is flouting one, two or all of them.
This message seems to be resonating with investors, too.

Despite the Covid-19-fuelled market sell-off in March, Morningstar’s European sustainable funds universe attracted $33bn in the first quarter of 2020. Overall, the European fund universe saw $163bn in outflows.
So, when you are considering how to fight the current or even next raging inferno, remember that the tools to help you suppress the blaze may already be at hand.

The UKRIS quantitative research surveyed 211 retail intermediaries and 155 institutional investors, with fieldwork conducted in Q4 2019 for the retail component and in Q1 2020 for the institutional component. The retail study included a mix of DFMs and IAs, while the institutional study gathered views from consultants, professional trustees, scheme managers, pension CIOs and trustees. The study provides detail on perceived market leaders across a range of different RI funds/strategies, crucial insight into how professional investors and their advisers assess these products, and steers on how to differentiate in an increasingly busy marketplace.
We are offering a package which includes the retail report and/or institutional report, a one-hour consultative workshop with the team to discuss the findings, as well as our comprehensive Responsible Investment Review, conducted in 2019. If you would like to know more about this influential study and how we can help you, please contact Richard Ley or Toby Finden-Crofts.

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