“Fighting coronavirus with your wallet”: The ESG investor approach

18 May 2020

Dr Arthur KrebbersHead of Sustainable Finance, Corporates

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Caroline HaasManaging Director and Head of Sustainable Finance, Financial Institutions and SSAs

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Varun SardaHead of ESG Advisory

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Phil LloydHead of Market Structure & Regulatory Customer Engagement

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5 minute read

In this article we examine some of the impacts of coronavirus on the functioning of ESG investment portfolios.

At times when markets are at their most fragile, the call for responsible investment is often loudest. The same holds true for coronavirus, which has in many ways reinforced the principles of sustainable fund management. It has also broadened their application. Environmental sustainability measures are important, but any ESG1-conscious fund can really no longer ignore social considerations.

In this article we examine some of the impacts of coronavirus on the functioning of ESG investment portfolios.

1. Fund performance

Many fund managers have been hit hard in the past months - did ESG-specialist portfolios fare better than most? Initial findings suggest they have.

MSCI ESG driven indices have outperformed their conventional “mother” index while Exchange-Traded Funds (ETFs) with more Morningstar “Globes” (their Sustainalytics- driven ESG classification) tended to be overrepresented in the top quartile of best performing ETFs in Q1.

While noting that each sustainable fund has its own mandate and strategy, and it is too early to “prove” full causation, several broad-brushed explanations appear to be emerging:

  • Corporate resilience: the highest ESG rated firms generally have the necessary policies, procedures and operational oversight to makes them better able to withstand external shocks – regardless of what part of their supply chain is hit. Even controlling for factors such as company size, these organisations are better organised and consider a broader range of stakeholders.
  • No-oil: typical exclusionary sustainability funds should have a highly constrained approach to the oil and gas sector, which has been one of the main underperformers this year to date.
  • Tech-focused: ESG funds tend to overweight technology firms, whose solutions are often critical to a carbon-neutral society. In an age of lock-down, this sector has done relatively well
  • Social-focused: portfolios considering social impact were naturally focused on sectors supplying “basic needs” such as food, healthcare and pharmaceuticals. These clearly have gained in prominence due to coronavirus.

2. Fund flows

Helpfully as well, sustainable funds have experienced relatively fewer outflows in recent weeks compared to conventional funds. This underpins the mindset of their typical asset owner – being more concerned about longer-term returns and non-financial impact of their investments. This was particularly noteworthy in the passive funds which experienced almost no outflows at the height of the market volatility at the end of March (source: EPFR). Of course, the fact that the fund performance has been steadier also helps!

All in all, the improved performance and fund flow dynamics should render a number of ESG portfolios more compelling to traditional end-clients seeking a (partial) hedge for future market disruptions.

With high profile asset managers launching new green and ESG portfolios in recent weeks, such as Blackrock and Robeco, it is expected that this fund flow trajectory is expected to continue.

3. Investments

ESG investors cannot afford to sit on their laurels, however. Many are actively considering how they should be managing their funds in response to coronavirus.

This starts with existing holdings. The Principles of Responsible Investment has called on its members to showcase “flexibility in financial arrangements” to support companies. In this context one would expect ESG investors willing to support covenant waiver / amendment requests as well as liability management transactions (extensions of existing bonds).

It also stretches to new types of holdings. A recent success story in this regard has been the surge in coronavirus-response bonds, a derivative of the established social debt market. End of April, NatWest Markets helped French financial agency, BPI launch its inaugural €1.5billion 7-year EUR Coronavirus Response Bond, which attracted high quality investors with a final orderbook of EUR 3.3 billion. A few days later, CAFFIL issued a €1 billion 5-year EUR Coronavirus Social bond led managed by NatWest Markets to finance public hospitals in France with a 4.5x oversubscription rate. Such sizeable orderbooks reflect a desire from investors, particularly asset managers, to “do their part”. There are parallels here with the early days of the green bond market. Investors wanting to start “doing something” about climate change piled into the first generation of green bonds.

This strong investor sentiment could even extend into wholly new fund offerings. Some have called for coronavirus index funds: funds screening firms for their social response to external societal shocks, such as coronavirus, as well as their broader human capital and community policies. Inclusion in such a fund would be a “badge of honour”, like for instance the FTSE4Good.

4. Engagement

A core part of the ethos of ESG investors is corporate engagement – challenging management on their sustainability practices. While the cry for tough carbon transition plans may be slightly less audible at the moment, investors are becoming more vocal on different topics (new ones for some), addressing what Schroders calls a “new Social Contract”. Topics mentioned by the Investor Statement on Coronavirus Response (statement signed by 250+ institutional investors) as well as other emerging ESG areas of focus include:

  • Human capital measures: How is management treating its workforce in the current crisis?
  • Supply chain: What steps are taken to make it more resilient? Are supply chains being supported during the pandemic?
  • Executive pay: Are senior management sharing the financial burden? Will the targets be upheld?
  • Vulnerable customers: How are firms making their products and services more accessible to customers affected by the crisis? Are they doing anything “beyond their call of duty” to support clients affected by the crisis? (e.g. telecom firms offering free data packages, industrials launching new protective equipment product ranges)
  • Broader stakeholders: How are Boards and executives addressing broader stakeholder interests from employees, suppliers and communities at this time?

Firms should anticipate more incomings either bilaterally or through virtual Annual General Meetings. Some investors are already taking a long-term view; not so much wondering about the shape of the recovery (V or U) but its colour: How green will it be?

We applaud such thinking. As we highlighted in our recent piece, the post-coronavirus world will lay a greater emphasis on sustainability topics. The public debate about which companies governments should bail out post-coronavirus has already kicked-off, with many taking the same stance as the Principles for Responsible Investment which recently said: “When the public health emergency of coronavirus starts to subside, government support should be prioritised for companies, sectors and business activities that help respond to crises such as the climate emergency and inequality, rather than those that risk exacerbating them.”

ESG investors will likely be on the frontline of this new paradigm!

Need to know more about the coronavirus crisis and how it will impact the economy? Find out more on our Coronavirus Insights Hub.

Sources:

https://www.morningstar.com/articles/976361/sustainable-funds-weather-the-first-quarter-better-than-conventional-funds
https://www.msci.com/www/blog-posts/msci-esg-indexes-during-the/01781235361
https://www.schroders.com/en/uk/adviser/insights/markets/a-new-social-contract---sustainable-investing-during-the-covid-19-crisis/
https://www.icgn.org/sites/default/files/ICGN%20Viewpoint%20Coronavirus-%20investor%20expectations%20of%20boards.pdf
https://www.law.ox.ac.uk/business-law-blog/blog/2020/04/covid-19-index-fund-new-fearless-girl
https://www.bmogam.com/de-en/intermediary/news-and-insights/esg-implications-of-the-covid-nineteen-pandemic/
https://www.schroders.com/en/uk/adviser/insights/markets/a-new-social-contract---sustainable-investing-during-the-covid-19-crisis/
https://www.unpri.org/covid-19

ESG/Sustainability
Coronavirus


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