Dean Bowden, Managing Director, Quilter Investors
Few things are certain right now but without a shadow of doubt the global pandemic will affect each and every one of us in some way, shape or form. For companies and investors we see the potential for two interconnected shifts arising from this crisis that could accelerate progress towards a more sustainable global financial system. Companies may adopt a more authentic version of social responsibility which directly challenges established business models and we could see a new wave of investors demanding investment strategies that go beyond ESG risk integration in pursuit of real-world social and environmental impact.
A more authentic version of social responsibility
The immediate fight against coronavirus has put company behaviour in the spotlight, heralding some previously unthinkable examples of collective action, innovation and capital reallocation. Media coverage has focused on how companies have responded to the crisis in the face of crippling business conditions. We’ve already seen luxury brands making hand sanitizer, smartphone manufacturers and clothing companies producing face masks, and Formula 1 teams using their collective skills to design and manufacture new breathing devices. On the flip side some companies have been criticised for continuing business as usual or worse taking advantage of the crisis.
Customers, employees, media and shareholders are all watching. The way companies behave in the darkest of times is more revealing than any corporate responsibility report. How organisations prioritise the needs of their employees and customers, use their skills and resources to contribute to the global response and what they learn and change in the process will be remembered.
The economic impacts of the coronavirus will be far reaching and for some sectors very deep indeed and possibly insurmountable. The impact comes both from the enforced pause of economic activity but also the longer term effect of lower consumer spending and a re-evaluation by consumers of what they need, want, value, and appreciate. Only time will tell how this will play out.
If a positive is to come of this crisis it could be that society calls time on tick-box corporate responsibility and companies take a more authentic approach; a version which doesn’t ignore the elephant in the room and if necessary challenges the future relevance of their core business strategy for a more sustainable economy. If, as some suggest, green investment leads the economic recovery then this shift would be most stark for fossil fuel focused industries, or those whose products cause people physical, mental or financial detriment. A re-evaluation of business and its contribution to a sustainable and inclusive economy is inevitable as a result of this crisis. How companies allocate capital and markets price risk will be under the microscope.
Fresh stimulus for responsible investment
These changes in the business community may also be related to evolution within responsible investment markets arising from the coronavirus. It’s likely that a new generation of investors will continue to expect companies to act in society’s interest, not just their shareholders, particularly given the economic recovery from the coronavirus-lockdown could take years to bear fruit. This could further fuel the growth of responsible investment funds which prior to the market sell off delivered £735m in net retail sales during February according to the Investment Association, a second consecutive month of record inflows.
This shift is perhaps an inevitable evolution which will be accelerated by the crisis. After all responsible investment has been around in various guises for the past 50 years. Between the 1970s and the millennium, it was somewhat of a niche sport, associated with single issues such as the Vietnam war, apartheid or animal testing. In the noughties work focused on determining whether responsible investment was compatible with fiduciary duty and saw the launch of the Principles for Responsible Investment backed by the United Nations. Following the global financial crisis governments became more engaged, leading to key milestones such as UN Sustainable Development Goals, the Paris agreement on climate change, the EC Sustainable Finance Action Plan and now a raft of new legislative changes to embed environmental, social and governance (ESG) considerations into European financial regulation. Just before we moved into a new decade the PRI reached over 2,500 signatories representing over $70 trillion assets under management.
From ESG risk to ESG impact
Responsible investment comes in different shapes and sizes, most recently defined by the Investment Association’s responsible Investment Framework. The crisis may stimulate a shift in the type of responsible investment funds in demand.
‘ESG integration’ is the dominant category behind the explosion of responsible investing over the last decade which requires the systematic and explicit inclusion of material ESG factors into investment analysis and investment decisions. These investment strategies can invest in any business, sector or geography as long as the ESG risks of such investments are identified and taken into account. Typically they rely on ESG ratings that assess how a company manages its ESG risks, effectively how it does business, rather than what it produces or delivers for society. This is where some confusion and greenwashing claims have crept in as portfolio holdings can be at odds with what others expect to see (or not see) in the top ten positions. Responsible investors have spent a huge amount of time focusing on the financial materiality of ESG, the quality of ESG ratings and the processes to incorporate these factors into portfolio management. Whilst this has been a powerful driver behind the expansion of responsible investment it’s valid to questions whether this delivers the scale of social and environmental impact in the real world needed to deliver a sustainable economic development and inclusive societies.
Perhaps the crisis will refocus investors’ attention permanently and increase appetite for investments that seek out positive ESG impact. This will force strategies to move beyond an approach that merely incorporate financially material ESG risk factors to ones that place sustainability at the centre of their investment philosophy in pursuit of tangible social and environmental outcomes.
Coronavirus has exposed the power of nature as well as the vulnerability and interconnectedness of our global systems. The crisis should be a wake-up call showing that we cannot continue economic development as usual; we must find a more sustainable way which operates within planetary boundaries. As we live through this crisis and begin to recover we could see a new wave of investors prioritising sustainable economic development and in so doing aligning the financial system with the needs of society.