ESG investing, or Environmental, Social and Governance investing, is using your money to invest in companies whose business practices align with your values. ESG investing can mean filtering out companies with business practices you don’t want to support, or it can mean putting your money into companies which have business practices which align with your values. Either way, investors have been reluctant to screen out profitable companies which may not meet their ESG requirements because they didn’t want to give up potentially higher returns on their investments. However, ESG investing has been gaining traction recently and may gain even more traction due to the effects of the COVID-19 pandemic.
There will be many lasting effects of the COVID-19 pandemic, even after the health risks are mitigated. We say with utmost sincerity that our hearts and thoughts go out to those impacted by the virus, and we give a special thanks to our healthcare and essential workers on the front lines. While the world awaits a vaccine, we anticipate long-lasting economic and societal impacts. One silver lining may be an increased awareness of the inherent value of doing the right thing in business practices.
1. ESG strategies expected to outperform
The growth of ESG investment strategies are directly related to their ability to generate alpha, meaning a return greater than the return which would be earned with a more passive investment strategy. During the first quarter (Q1) 2020 market downturn ESG passive and active strategies outperformed noticeably leading to record inflows. In Q1, 24 of 26 ESG index funds outperformed their conventional index benchmarks across US, non-US, developed markets, and emerging markets, according to Morningstar. For example, the S&P 500 ESG Index, MSCI ACWI ESG Leaders Index, and Russell 1000 ESG Index each outperformed their traditional, non-ESG counterparts. The results remain favorable even when looking across all ESG equity open-ended or exchange-traded funds (ETFs) in the United States with 44% ranking in the top quintile of their Morningstar category and only 11% finishing in the bottom quintile.
2. The “S” in ESG is increasing in recognized value
Companies with superior human capital practices and policies may strengthen long-term competitive advantages via stronger employee morale, customer loyalty and brand value. George Serafeim, Harvard Business School Professor, commenting on Corporate Resilience and Response During COVID-19 notes that “companies responding in a way that protects employees (avoiding lay-offs, paying sick leave), manages supply chain risk (safety to avoid disruptions) and re-purposing operations to provide solutions (producing masks, ventilators) had higher institutional money flows and less negative returns.” Increasingly, people recognize the positive correlation between a company that does well by all of it’s stake-holders and a company that is successful in the market place.
3. The importance of shareholder engagement
ESG issues continue to be important shareholder engagement topics for institutional investors. Data shows a noticeable upward trend in investors supporting environmental and social shareholder proposals and putting pressure on the Board of Directors at pubicly traded companies to prioritize the ESG concerns of investors. We believe that investors will increasingly deploy shareholder engagement techniques to help drive shareholder value and push for positive change.
4. Environmental effects of ESG policies more evident
The International Energy Agency (IEA) warned that the economic fallout from COVID-19 could slow the transition to clean energy. Collapsing energy demand will likely have a near-term negative impact on private sector investment and falling prices on EUs emission trading scheme may decrease incentives for renewable energy investments. While this could slow near-term progress, long-term ESG pressures remain. NASA revealed that air pollution – measured by nitrogen dioxide (NO2) levels – was 30% lower in March 2020 between Washington DC and Boston compared to the March average between 2015 – 2019. And European Space Agency’s Sentinel-5P satellite shows NO2 falling by as much as 40% in late January and early February 2020 relative to one year ago across industrial areas in Asia and Europe. We believe that long-term green policies will continue to be enacted as the link between air pollution resulting from industrial activity and human health become more apparent. Debates in Europe and South Korea are underway with leaders working to include Green New Deal initiatives in post-pandemic recovery plans.
ESG investing is expected to gain popularity as businesses who consider the impact of their policies on all stakeholders are rewarded. ESG investing used to be viewed as a niche investment filter for certain investors, but was viewed as too limiting for most investors. It is evolving into a viable way to filter for companies which have the fundamental business policies in place to make the companies more profitable and better able to sustain potential bumps in the road over the long term. If you’d like to find out more about ESG investing and how it may fit into your portfolio feel free to contact us at firstname.lastname@example.org.
Provided for general education and informational purposes only. May 2020 © Access Financial Planning, LLC