As we adjust to life with the coronavirus, uncertainty is the rule of the day. But one clear lesson is emerging: “business as usual” is over for companies that expect to thrive long term.
Entire sectors are mobilizing en masse, with companies called on to accelerate technology and individuals required to take action for a collective goal. This orientation towards a clear and stated purpose is a microcosm of an already prevalent theme. Investors are rewarding companies with fundamentally sound, sustainable business models that are geared to advance societal goals. They are punishing those that hold back progress.
Investors ushered in this new reality by embracing environmental, social, and governance (ESG) analysis as a gateway to sustainable investing. Thoughtful application of ESG research helps investors better understand a company’s impact on the environment, their workers, supply chains, and the communities in which they operate.
The pandemic is sharpening the focus on how companies manage ESG risks. Those that have been quick to respond are demonstrating the power of good governance with well-organized responses and thoughtful leadership. The direct connection between ESG and corporate value has never been more relevant: ESG risk is business risk, financial risk, and investment risk.
For clear evidence of ESG’s effectiveness, simply look to the performance of sustainable funds during the coronavirus-induced selloff. According to Morningstar’s latest research through March 31, year-to-date 70% of actively managed ESG mutual funds outperformed their peer groups, with 44% placing in the top quartile. About 92% of sustainable index funds outperformed their benchmarks. While acknowledging an underweight to oil and overweight to technology helped, Morningstar noted that “perhaps the biggest reason for their outperformance is that sustainable funds appear to have benefited from selecting stocks with better ESG credentials.”
The private sector already has begun to align behind key sustainability issues. Before the coronavirus spurred companies to be more proactive with their societal obligations, there was an institutional movement toward redefining the role of a corporation. This was codified by the well-noted August 2019 statement from the Business Roundtable, which called for shifting the focus from shareholders to all stakeholders including workers, customers, suppliers, local communities, and society at large.
Since that time, there has been a steady pulse of major headlines in support of sustainable investing. The World Economic Forum released its annual list of global risks, the top five of which are all related to climate change. BlackRock CEO Larry Fink announced the firm would divest from coal in their actively managed funds, representing one of the largest divestments to date. Blackrock, State Street, and JP Morgan joined Climate Action 100, which should lead to corporate accountability on climate.
The mainstreaming of sustainable investing goes even further. Ratings agencies, central banks, insurers, and corporate lenders incorporate ESG risks into their assessments. There is now a clear and direct line from a company’s ESG performance to cost of capital, profitability and share price volatility. Pensions and other institutional asset owners have been early adopters of ESG as a way to protect downside risk and drive long-term value. Wall Street has finally awakened to the fact that sustainability factors are financially material. Fink framed this succinctly: “Climate risk is investment risk … awareness is rapidly changing, and I believe we are on the edge of a fundamental reshaping of finance.”
If the coronavirus pandemic injects society with the realization that we have the necessary tools and speed to meet this challenge, that narrative may change. At minimum, the advances we’ll see in the coming months will deconstruct artificial barriers and weaken political constraints. At maximum, we will start operating as a finely tuned machine with a unified vision.
Either way, the investment landscape will take shape around these themes. Calculating risk and return without considering ESG will be a fool’s errand, weighed down by legacy thinking and a pre-COVID-19 worldview.
The coronavirus will eventually recede, but it is a reminder of what large swaths of society can accomplish when united around a common goal. The world can turn its attention to the climate crisis with a renewed sense of urgency and confidence.
The financial markets are already primed for this direction. There has never been a more compelling opportunity for investors to mitigate risk, enhance long term returns, andelevate companies that promote sustainability. With clear data, sound science, and an engaged society, investors and their capital stand to play a key role in determining winners for a sustainable future.
Bud Sturmak is Co-CIO and partner at Perigon Wealth Management and Evan Zall is president of Longview Strategies.
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