The coronavirus pandemic has upended many industries, spawned new trends and accelerated others. In the world of investment, particularly, the Covid-19 pandemic has proved to be an inflection point for environmental, social and governance (ESG) investing.
The investment strategy has been around for decades, but has been booming in recent years. Unshackled by a myriad of myths and investor scepticism that held it back, ESG investing, also known as sustainable or responsible investing, is now having its day in the sun. For a growing legion of investors and businesses, ESG issues are now key economic determinants with significant bearing on profitability.
In a world currently dominated by Covid-19, there is little surprise that sustainable investing is having another banner year in 2020, clocking record capital flows into ESG funds. In the US, ESG funds so far this year have hoovered up a staggering $10.4 billion, according to a Morningstar report. This brings the tally for the first half of the year to $20.9bn, nearly matching the $21.4bn that investors ploughed in sustainable funds in the entire year of 2019. It may be noted that 2019 net inflows were four times the rate of inflows in 2018. Evidently, the trend is well anchored.
The adoption patterns for sustainable funds in the UAE are consistent with global trends. A study conducted by UBS Global Wealth Management polled more than 5,300 millionaires across 10 markets including Brazil, China, Germany, Hong Kong, Italy, Singapore, Switzerland, the UAE, UK and US, and found that the highest rates of adoption in sustainable investing was in the UAE.
The study further showed that UAE investors expect sustainable investing to grow from 53 per cent of investors to 66 per cent over the next five years. Three quarters of investors (75 per cent) expect it to become the norm in a decade, handily topping the global average of 58 per cent.
Then along came the Covid-19 crisis, which turbocharged demand for ESG-enabled investment instruments. Here, we look at the key themes in the ESG investing space arising as a consequence of the pandemic and global response to it.
Covid-19: a long-term catalyst for ESG
The Covide-19 pandemic has ratcheted up the importance of mitigating risk in investment strategies arising out of natural and man-made calamities. Issues relegated to the political backburner have roared to life again. Coronavirus, the wildfires in California, the Australian bushfires, global warming, clean energy, and racial and gender equality; everything is now on the table and under the ESG umbrella.
For that reason, the events of the recent past will prompt investors to put greater emphasis on a company’s ESG performance alongside traditional financial metrics.
"We expect increased investor focus on ESG considerations after Covid-19, with particular demand for greater corporate transparency and stakeholder accountability," says UBS Global Wealth Management in a recent note to clients.
This could be a tipping point for the ESG market. "A substantial shift is under way: stakeholders are increasingly pricing in sustainability preferences, which should lead to a reconciliation of 'sustainable' and 'financial' materiality over the long-term," a JPMorgan research note says.
Covid-19 has turned our attention to what matters in life, says Ron Robins, an investor analyst and founder of investingforthesoul.com. "The importance of health, the environment and the way we relate to each other has come under renewed attention," Mr Robins says.
The pandemic has underscored the vulnerability and fragility of societies and the planet. “The global public health crisis has acted as a wake-up call in many respects,” Nigel Green, chief executive and founder of financial advisory deVere Group, says. “It has prompted a growing collective awareness of mutual responsibility that fits perfectly into the narrative of ESG investing.”
ESG funds are also attracting record levels of cash because of their market-beating performance. Sustainable funds continue to best conventional funds in a year riddled with great uncertainty.
“These issues have underscored the need for investors to consider ESG-related risks in their portfolios and have affirmed the value of sustainability within the mainstream of investing,” says Jon Hale, Morningstar's director of ESG research.
The recent investment data bear out these assertions. A September report from the Morgan Stanley Institute for Sustainable Investing found that not only did sustainable funds reduce investment risk during the pandemic, but they also outperformed their traditional peers by nearly 4 per cent in the first six months of the year. For the same period, sustainable taxable bond funds beat out their non-ESG counterparts by 2.3 per cent, according to the report.
Outsized returns have helped global sustainable funds reel in a whopping $45.7bn, just as the broader fund universe suffered an outflow of $384.7bn, in the first quarter of 2020, according to Morningstar data. A JPMorgan report goes so far as to forecast ESG investing is set to scoop up $45 trillion in total assets by the end of the year, with Europe and North America accounting for more than 90 per cent of that.
“The data shows that the view held by traditionalists who claim ESG investments are ‘nice to have’ but not ‘a need to have’, falls apart under scrutiny in the virus-driven global economic downturn,” Mr Green says.
“Whilst this short time frame is not determinative, those investors citing ESG’s safe-haven credentials are, for now at least, being proven right.”
Why investors should care
The ESG investing trend is here to stay for many reasons. One of the most compelling of those is the demographic shift that will support the trend, Mr Green says.
“Millennials cite ESG investing as their top priority when considering investment opportunities,” he says. “This is crucial because the biggest-ever generational transfer of wealth – likely to be around $30tn – from baby boomers to millennials will take place in the next few years.”
Looking ahead, experts forecast a diversified portfolio of global sustainable investment equities and bonds to deliver solid performance overall. "Allocations to ESG themes and ESG engagement equities and high-yield bonds will be the cornerstone of growth and returns opportunities," says a report from the Morgan Stanley Institute.
At the core of ESG investing is the belief that companies that embrace better business ethics, respect for human dignity and environmental responsibility are able to create more economic value over time. “The pandemic has highlighted that, increasingly, companies will only survive and thrive if they operate with a nod from the wider court of public approval,” Mr Green says.
The crisis has also demonstrated “the complexity and interconnectedness of our world in terms of demand and supply, in trade and commerce, and how these can be under threat if not sustainable”, he adds.
ESG vehicles to park funds in
Companies with strong ESG credentials are well positioned to benefit from the surge of interest in ethical investing. The increasing regulatory and investor push for sustainability has compelled a growing number of corporations, including Walmart and Apple, to clean up their act and roll out ambitious green initiatives with a promise for a cleaner tomorrow.
Investors are acutely aware that it is possible – and increasingly necessary – to make a profit while positively and proactively protecting people and the planet. This has spawned a plethora of green exchange-traded funds incorporating companies with high sustainability credentials.
Investors can now choose from a bounty of cause-specific funds including renewable energy funds, fossil free funds, women’s leadership funds, or even vegan funds.
The SPDR S&P 500 Fossil Fuel Free ETF, for instance, avoids fossil-fuel stocks. Another ESG-integrated ETF, SPDR SSGA Gender Diversity Index ETF is pegged to an index that tracks US companies known for promoting gender diversity. These and many other ESG funds are attracting significant allocations, led by BlackRock’s iShares, which have 21 ESG funds in its line-up.
While the human and economic costs of the pandemic continue to mount, the long road to recovery may provide the perfect opportunity to plan a sustainable reset for the way we do things, investing included.