Does ESG Shine In The Dark?

Mixed signals have been given throughout the COVID19 crisis; Larry Fink insists on the fact that ESG is a top priority yet 52% of investors in the USA deem that it is unnecessary to fully pursue ESG related objectives during such unprecedented and arduous times. All of this leads us to question where ESG stands amidst the crisis.

How did the pandemic affect the interest in ESG-equities and their stock market performance?

Back in February, Blackrock had warned investors of the need to prepare for a potentially drastic repricing of assets as huge sums of money were flowing into sustainable investment products. According to Blackrock, “markets were a long way from fully pricing in the far-reaching consequences of changing attitudes toward sustainability because structural shifts were typically under-appreciated for long periods of time by financial markets.” Therefore, how will these developments and the pricing of the assets affect their demands and returns now that society will care much more about sustainability in the future than it has in the past?

First of all, since BlackRock published its findings just before the pandemic really took its toll, we may now ask whether the current investor sentiment still encourages that long-running momentum trade and whether ESG-stocks are still in high demand. A first glance at a comparison between performances of ESG-companies and non-ESG companies during the crisis will provide hints on whether there might be a temporary shift towards return maximizing portfolios, which could curtail the ESG-momentum. While many standard operations are being upended by the coronavirus pandemic, it will be essential to observe just how much companies value their sustainability goals – and whether those goals survive when a business is just trying to stay afloat. With coronavirus bringing global commerce to a screeching halt, sustainability is feeling like an unaffordable luxury for some cash-strapped companies. 

“I suspect an awful lot of the environmental agenda and targets will be put on the back burner for a number of years,” said Michael O’Leary, chief executive of Ryanair in this regard. According to him, major political issues such as massive unemployment across Europe as well as massive government indebtedness will be the driver for that reversion. His assertion may be misguided and biased, however. 

Contrasting O’Leary, investors are still going all in on ESG themes – and so far their bets pay off, as reported by the FT. Indeed, if anything, the pandemic had only reinforced fund managers’ belief that ESG was worth worrying about. Sustainability-themed funds saw record inflows in the US in the first quarter, as opposed to the rest of the market. On top of that – many ESG indices held up better through the downturn than their broad-market counterparts. Data from MSCI show that corporate bonds and equities with high ESG ratings have markedly outperformed the index recently. The MSCI KLD 400 Social Index, the MSCI World ESG Leaders Index, and Refinitiv Eurozone ESG Select Index were up by 200 to 320 basis points relative to their non-ESG counterparts in the 12 months ending on April 30th. Morningstar has shown that in a comparison of 26 sustainable index funds with conventional index funds, 24 of them outperformed the comparable conventional index fund in the first quarter of 2020. Companies with high ESG rankings have outperformed rivals during the crisis. That means interest in ESG is likely to rise – not fall – according to Frédéric Samama, head of responsible investment at Amundi. “Companies are more and more scrutinised and ESG factors can be a way to assess the adaptability skills of corporates,” he says. Thus many investors and some chief executives argue that a key theme of the coming months will be not simply how to rebuild the economy after the COVID19 shock — but how to build back better, in the sense of creating a more sustainable world and corporate sector alike. 

Many investment departments of large banks share the same view. “Talking to clients across the board, the reasons they want to integrate ESG have been supported and amplified by the crisis,” said Ted Eliopoulos, co-chair of the sustainable investing council at Morgan Stanley Investment Management. The COVID19 crisis will serve as a good “laboratory” for investors to test the theories underpinning ESG investing. “We’ll see which companies were able to anticipate, mitigate, and manage through this crisis better or worse,” says Eliopoulos. He argues that sustainability is a long-term play. “The link between sustainability and index-beating returns is clear,” he said. “If anything it has probably put a period at the end of that sentence.”

In terms of ESG performance during the crisis, it seems fair to say that integrating an ESG lense on an equities portfolio added a significant level of protection during the first quarter of the year.

So where is ESG headed?

The scope and breadth of the COVID19 crisis initially point towards investors and companies that are shying away from ESG matters. Yet, given the performance of ESG portfolios during the crisis, it would seem that ESG is here to stay. When prominent figures such as Larry Fink and Nick Robinson increasingly bolster ESG issues, it seems reasonable to say that ESG is an essential preoccupation with a long standing importance.

Nevertheless, it is necessary to recognize that interest in ESG is significantly phased. During a media conference call in April, John Goldstein, Head of the Sustainable Finance group at Goldman Sachs, emphasized on the changing nature of the interest for ESG: “Someone the other day said: ‘has environment taken a back seat? And my reply was ‘no, it’s more the ‘S’ has climbed into the front seat’”. Potentially, the aftermaths of the crisis will reveal the significant importance of the ‘G’, already a way to now distinguish fallen angels from zombies. 

For now, Robinson identifies the “green” aspect of SF as one of the five priorities of finance, and he stresses that by 2030, all financial institutions and regulators will need to be taking action to achieve alignment with net zero carbon emissions. The recovery plans that are currently being elaborated must be designed such that they are consistent with the Paris Agreement of 2015.

Apart from companies and banks, the political sphere seems to be going in this direction as well. On April 8th 2020,  the European Commission launched a public consultation on its “Renewed Sustainable Finance Strategy”, a part of a €1 tn package to make the European economy greener by 2030. “We are currently battling the coronavirus outbreak, but we must not lose sight of our long-term sustainability objectives, including making Europe climate-neutral by 2050,” said Valdis Dombrovskis, the EU Commission’s executive vice-president in charge of the economy. He added that “creating a more sustainable and resilient economy would be a key focus of the recovery phase and the Renewed Sustainable Finance Strategy would be essential to mobilizing much-needed capital.”

Sustainable finance as a way to save and recover the global economy

As a result, SF moves to center stage as solutions for the economic recovery from the COVID19 crisis are being discussed. The pressing interest for ESG is, to say the least, neither anecdotal nor temporary. It is a cornerstone of a sustainable and sustained recovery. ESG is not going anywhere according to a team of Moody’s Investors Services analysts: “Greater emphasis on social finance and sustainable development will likely be one of the lasting outcomes of the coronavirus crisis.” Today’s situation serves as a compass for ESG matters. As developed by IRENA in the report of ‘Global Renewables Outlook: Energy transformation 2050’, ESG will contribute to a withstanding recovery.   

The crisis that we are facing today calls for an opportunity for transformation. According to IRENA, a full economic recovery through the implementation of sustainable structures is attainable and feasible. This group proposed a $110 trillion-dollar plan that is expected to send the economy skyrocketing, with an estimated global GDP increase of 2.4% in the near future. In order to keep business going as usual, current global plans are expected to amount to $95 trillion dollars. However, the first solution, set forth by IRENA, will have sizable and more substantial outcomes for the economy. Following the path of decarbonization, the plan proposed by IRENA is expected to generate massive socioeconomic gains as well as massive savings. A sustainable recovery is achievable through other means. Indeed, amidst the crisis, the issuance of so-called social bonds has gone through the ceiling in a matter of months. These instruments raised in order to provide money for projects with positive social consequences have hit consecutive record highs in March and April ($12bn for April). The issuance of social bonds could lead to significant proceeds in the education industry and healthcare industry, that we have seen get debilitated as a result of massive government cuts in the industry. 

The context of the current crisis related to COVID19 adds significant urgency to the ESG agenda. Sustainable Finance could potentially be a way, if not the way to restore sufficient means in the healthcare industry that has suffered notable setbacks and many others. The recovery plan proposed by IRENA and the vigorous emission of social bonds could in turn result in a sustainable response to the pandemic. Furthermore, we can clearly observe that ESG indices have outperformed their counterparts even during the crisis, which can be a significant catalyst for a sustainable overhaul of our economy. What’s more is, that ESG metrics will play an important role in identifying the right ways of how to “build back better” – in the sense of creating a more sustainable world and corporate sector. We have also shown that ESG remains a top priority in the minds of the world’s biggest asset managers. Nevertheless, it is important to remember that amidst the crisis,  a handful of  investors were skeptical of  the need to pursue ESG obligations therefore encouraging relatively irresponsible behavior in accordance to ESG. Such a stance could belittle and discredit the relevance of ESG matters and SF  as a whole in the economic recovery from COVID19.

Authors: Lukas Rombach, Edoardo Castangia, Oumaima Sadouk 

Sources:

Sustainable finance is performing well in the pandemic—but why? 

https://qz.com/work/1856470/why-sustainable-finance-performs-well-in-the-pandemic/

Financial Times. “Coronavirus is strengthening the hand of ESG investors”

https://www.ft.com/content/19047cda-0648-48a9-a512-87653149026c?shareType=nongift

Deloitte Report. “Advancing environmental, social, and governance investing”

https://www2.deloitte.com/us/en/insights/industry/financial-services/esg-investing-performance.html#endnote-sup-4

BlackRock report. “Sustainability: The tectonic shift transforming investing”

https://www.blackrock.com/corporate/compliance/insights-terms-and-conditions?targetUrl=%2Fcorporate%2Finsights%2Fblackrock-investment-institute%2Fpublications%2Fsustainability-in-portfolio-construction

How A $110 Trillion Green Recovery Can Save The World: New Report

https://www.forbes.com/sites/davidrvetter/2020/04/20/how-a-110-trillion-green-recovery-can-save-the-world-new-report/#3506d24b4914

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