What the Pandemic Means for Sustainable Investing
Jon Hale sees resilience in ESG funds, an appreciation for 'social' analysis, and a hastening toward stakeholder capitalism.
|Editor’s note: Read the latest on how the coronavirus is rattling the markets and what investors can do to navigate it.|
The global coronavirus pandemic has shone a light on sustainable investing. Funds that use environmental, social, and governance analysis as a key part of their investment approach held up better than their conventional peers in the first-quarter downturn. These same funds entered the year with trailing returns that were, on average, better than those of their peers. And as of this writing, which now includes the initial April-May market rebound, 70% of sustainable funds in the United States still reside in the top halves of their Morningstar Categories. Sustainable funds have also experienced record flows in the U.S. so far in 2020.
Today, I take a look at what a few prominent sustainable investors have had to say recently about the effects of the pandemic on sustainable investing.
BlackRock: Resilience amid uncertainty.
Let's start with the world's largest asset manager, BlackRock, which sees sustainability as fundamentally reshaping finance. The firm announced this year that it is putting sustainability at the center of how it invests and has been building out its ESG suite of iShares exchange-trades funds, which now number 15 available to U.S. investors.
In a report released last week, BlackRock argues that ESG insights help investors uncover more-resilient companies. For starters, the report notes, the correlation between sustainability and traditional factors, such as quality and low volatility, suggests greater resilience during downturns. Beyond that, the report finds that the outperformance of sustainable funds was "driven by a range of material sustainability characteristics, including job satisfaction of employees, the strength of customer relations, or the effectiveness of the company’s board."
BlackRock's conclusion: "Overall, this period of market turbulence and economic uncertainty has further reinforced our conviction that ESG characteristics indicate resilience during market downturns."
Parnassus: Understanding firms as part of a system.
Moving to a smaller boutique active manager that nonetheless has more assets in sustainable funds than BlackRock, at least for the time being, Parnassus has been focused on sustainability since its 1984 founding.
To Parnassus CIO and comanager of Parnassus Core Equity, Todd Ahlsten, sustainability has a lot to do with systems thinking--understanding how a company fits in the bigger socioeconomic context and how its stakeholders interact to make it successful. In a recent piece called “Navigating Turbulent Markets” Ahlsten writes:
"Our investment team has deep experience thinking about ESG issues in the context of managing a portfolio, which can be helpful during a crisis. We are used to thinking about systems. For example, how companies interact with their communities, workers and supply chains is already an integral part of our process. These are the kinds of things we think about when developing a view on which companies are going to make it through the downturn, and which may likely do well as a result of this crisis."
Parnassus has always been especially focused on how companies treat their employees and this, Ahlsten notes, will be a key going forward.
In a recovery, "companies that are able to avoid furloughs and layoffs will do better than others. They will be able to stay productive and keep employee morale up. They won’t need to rehire, retrain and integrate new employees into their businesses when the economy improves. Notably, companies that are hiring now have a huge advantage."
Companies that can keep their workers on the job, especially those with characteristics like strong balance sheets, high profit margins, and relatively low leverage, will likely gain market share as weaker competitors lose ground or fail. "We are also favorably inclined to companies that aren’t cutting their R&D budgets because innovation will be very important for gaining market share as our economy recovers," writes Ahlsten.
Calvert: Long-term corporate reputations at stake in pandemic response.
Now owned by Eaton Vance, Calvert is the only fund manager in the U.S. that offers a full lineup of 28 equity, fixed-income, allocation, and sector funds, all with a sustainability focus.
The bottom line for Calvert, says CEO John Streuer: "We believe that how companies respond to stakeholders during COVID-19 is likely to affect their reputations and drive long-term value for years to come. Calvert is closely monitoring company responses to this crisis as a key indicator of how resilient, prepared and accountable they might be in facing future risks."
Calvert is developing a proprietary measure that will rank companies based on how well they were prepared for and responded to the pandemic. The firm believes the measure not only will be an indicator of how well companies manage during a recovery, but also how they might deal with future crises and climate change.
"In times of crisis, companies and governments have an opportunity to take major steps forward in the eyes of their key stakeholders and establish or deepen a relationship built on trust," writes Streuer.
"Those that perform well right now, serving their customers, employees and communities, will benefit in the long term, winning customer support and loyalty. Those that perform poorly, on the other hand, are likely to find that customers have long memories of crisis-era actions."
ClearBridge: Engagement in support of all stakeholders.
A subsidiary of Legg Mason, ClearBridge runs several sustainable strategies including the ClearBridge Sustainability Leaders Fund.
In “The Coronavirus and ESG Engagement,” Mary Jane McQuillen, comanager of that fund, and several colleagues emphasize their engagements with portfolio companies during the pandemic. "In our conversations with companies we own, we are sharing our intentions and learning of innovative solutions already undertaken across industries and business models to support all stakeholders through the coronavirus crisis." Engagement is a way to understand best practices and to spread knowledge of best practices among portfolio companies. This is a key facet of sustainable investing.
Fitting this all together leads me to three conclusions about the pandemic and sustainable investing.
First, sustainable funds are proving themselves to be resilient in a down market, something many of them hadn’t had the opportunity to demonstrate prior to the pandemic. And they're proving resilience because ESG insights help investors identify companies that can focus effectively on the well-being of multiple stakeholders--workers, customers, communities, and supply chains. A focus on stakeholders is exactly what the currently situation calls for.
Second, the pandemic is generating wider appreciation for the importance of the "social" dimension of ESG analysis. Company policies and treatment of workers, customers, and communities is what the “S” in ESG is all about. Most professional ESG analysis emphasizes these areas, particularly in industries where they are most material to financial performance, but many end-investors have the impression that sustainable investing is mostly about the “E” in ESG, especially climate change.
When companies do things like increase healthcare benefits, hike pay for workers on the front lines, lower executive compensation to help avoid layoffs, and take extra steps to protect worker and customer safety, they will benefit from having a more-engaged and productive workforce and a more-loyal customer base during a recovery. By putting the spotlight on a company’s treatment of workers, customers, and communities, the pandemic is helping advisors and their clients understand that sustainable investing extends beyond environmental considerations.
Finally and bigger picture, the pandemic seems likely to hasten the movement toward stakeholder capitalism. That means a shift away from a narrow focus on short-term profit maximization, toward long-term value creation that benefits all stakeholders. We may see support for this from policymakers, as they consider whether to limit share buybacks, add employees to boards, or limit executive compensation.
But I think the existential crisis of the pandemic itself will sway more companies toward a stakeholder model. Many will realize a focus on stakeholders is what helped them survive the crisis, while the recovery will require a “we’re all in this together” ethos. Post-pandemic, public expectations for corporate purpose and responsibility will be heightened.
Sustainable investing, as I’ve argued before, has a major role to play in helping companies move toward a stakeholder model. The more corporate CEOs see their shareholder base as supportive of such a move, the more likely it is to happen.
As a result of these factors, I think we’ll continue to see assets pour into sustainable funds. The intermediary and advisor pinch points will be further relaxed, with fewer attempting to wave away interested clients from the idea, and more recommending sustainable investing as an appropriate way to manage risk and promote the common good.
Jon Hale has been researching the fund industry since 1995. He is Morningstar’s director of ESG research for the Americas and a member of Morningstar's investment research department. While Morningstar typically agrees with the views Jon expresses on ESG matters, they represent his own views.