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Crisis and resilience - Navigating a sustainable recovery
THE Covid-19 pandemic has resulted in tragic human cost and catalysed a global response from governments, public and private institutions - the scale and impact of which are unprecedented in peace-time. The engineered shut-down of large parts of the economy, while necessary to constrain the spread of the virus, has resulted in a demand shock that has dealt a blow to many businesses.
The economic and human impact of the pandemic has refocused investor attention on two key questions: first, what does it mean for a business to be truly sustainable or resilient? Second, will we see a green or sustainable recovery, or will sustainability take a back-seat to economic revitalisation?
Business resilience is at the core of sustainable or Environmental, Social and Governance (ESG) investing practices. A common objective of integrating ESG into fundamental investment practices is to enhance the identification and mitigation of risk by considering a broad range of financially material issues that may not be captured by traditional financial analysis. This can include extending analysis beyond traditional measures of economic performance to include a focus on treatment of different stakeholders such as providers of capital, employees, the government, communities and the environment.
If the scales are tilted too far in the direction of one group of stakeholders, it can build in a source of long- term business vulnerability or inequitable outcomes - balance is key. For example, incentive structures and a focus on short-term performance could contribute to a company 'over optimising' the balance sheet to enhance returns to providers of capital. This could make the company more vulnerable to economic variability and without a 'cash cushion' - resulting in staff layoffs and potentially a government bail-out.
So how have ESG funds performed during the crisis?
In the first quarter of 2020, the four MSCI ACWI ESG indexes outperformed the underlying MSCI ACWI index by between 70 bps and 290 bps. This outcome was also supported by an analysis by Morningstar of 206 sustainable funds in the US funds during Q1 2020: 44 per cent had top quartile performance versus peers and 70 per cent had top-half performance versus peers.
Although the resilience of ESG investment strategies and indexes to date has been encouraging, the value of ESG analysis to an investment process should be evaluated over longer-term time horizons. The risks and opportunities identified may be structural or long-term in nature (for example, energy transition away from coal / fossil fuels) and may take some time to be reflected in asset prices. This disconnect creates opportunities for ESG investors, but it is important to be conscious that other factors can dominate share price movements over short time horizons.
Building a sustainable recovery
There has been a wide range of approaches to economic recovery plotted by countries globally - from doubling down on green and equitable economic development, to supporting new coal-fired power generation assets as a vehicle for economic growth.
As the world gradually re-opens for business, and billions of dollars of financial stimulus are deployed, will we build for the future or just focus on the present?
The economics of green and renewable energy solutions have been improving rapidly, and could represent an opportunity to direct economic stimulus towards enhancing the energy transition towards low or no carbon alternatives.
Public support of sustainable investment also appears to be becoming more mainstream. Despite the uncertainty and volatility during the first quarter of 2020, US sustainable funds saw a record quarter of inflows at US$10.5 billion. This is evidence of both an ongoing shift in consumer and investor behaviour and the rapid growth and availability of sustainable investment products.
Just six months ago, the idea of a lock-down and closure of entire segments of the economy would have been unthinkable. The global response to the pandemic has highlighted the scope and power of what can be achieved with strong resolve and coordinated effort in the face of a salient threat.
The threat from the novel coronavirus is a clear and present danger, but may be dwarfed in the long term by the impact of the climate emergency. With this in mind, when we emerge from the current predicament, a key question will be if the collaboration and focus can be maintained and harnessed to address the climate crisis or other global issues requiring a focused and coordinated response.
- The writer is head of stewardship Asia-Pacific BNP Paribas Asset Management