Coronavirus intensifies thirst for new responsible capitalism
The Covid-19 pandemic is an ESG issue. More than ever before, a natural phenomenon is driving markets. Suddenly, social responsibility is no longer kooky but required of all. How are responsible investors reacting — and can the crisis lead to a better model of financial markets, where all stakeholders are considered?
In a matter of weeks, the coronavirus crisis has changed economies, lifestyles and the physical environment. But has it changed investing?
The first priority of all investors has been to protect their clients’ capital, and try somehow to still earn them a positive return. Loftier concerns, such as the environmental and social qualities of investments, might be expected to be discarded as markets crashed.
But those who specialise in responsible investing and environmental, social and governance (ESG) analysis are finding it is quite the opposite. The world is now joining in their conversation.
Jennifer Kenning, locked down at her home in Denver, Colorado, is CEO of Align Impact, an impact investment adviser based in Santa Monica.
“The demand from family offices, foundations and ultra-high net worth individuals is through the roof,” she said. “They are seeing [ESG and impact investing] as an opportunity that’s not nice to have, but must-have. Investors are saying ‘I’m ready to go in this direction’.”
March was Align Impact’s busiest month ever, and April is also proving very strong. This is while many other kinds of investment are suffering outflows, or at least having to put fundraising on hold.
There are many reasons for this surge, but most fundamentally, investors can see society facing a crisis and want to help. “They are asking: ‘can we factor in the impact [in terms of] race and gender?’,” said Kenning. “Or ‘What can we do in three to 12 months to get capital where people are starved of capital?’”
The sense that investors feel a duty to help society is fundamental to responsible investing — even if many practitioners prefer to say they take into account ESG purely to improve investment performance.
Covid-19 has brought that sense of social responsibility to the top of every agenda — in government, company boards and households.
“The first priority is to deal with the crisis and everyone is focusing on that,” said Julie Hudson, global head of ESG at UBS Research in London. “The health and wellbeing impacts have to be to the fore. In a market context, it’s also about balance sheet resilience and company survivability; and because of that, it’s also about people continuing to have the wherewithal to live if they lose their jobs when firms struggle.”
But is this new social consciousness more than skin deep? Will it survive when the coronavirus dies down? And how should investors engage with it?
One way in which ESG investors feel encouraged by the past two months is how radically society has reacted. “If we had doubts of whether we could change behaviour around climate, we’ve proved them wrong in under four weeks,” said Kenning. “We have drastically shifted our behaviour [with the effect of] less impact on the climate.”
Travel by car and aeroplane — big contributors to climate change — have shrivelled. That opens up a chance that when people and companies go back to work and normal life, they will not revert to the same, unsustainable practices.
“It’s almost like the Earth said: we’re going to pause now, and we can rethink this,” said Kristin Hull, founder and chief executive of Nia Impact Capital, a fund based in Oakland, California.
UBS’s sustainability analysts have tried to map how that rethinking might be done, through the lenses of several existing economic models.
One source of inspiration was Isabella Tree’s book Wilding: The Return of Nature to a British Farm, which tells how a farm shifted from intensive farming to letting nature “rewild”.
Stakeholder hierarchy upset
However, the strand where most activity has been apparent so far is in stakeholder relations.
Companies are starting to consider a broader range of interests, beyond those of their shareholders. They have been cancelling dividends and share buy-backs, or cutting pay for executives, while supporting employees.
“This whole questioning of shareholder primacy, the need to move to a more balanced regime of capital markets, is something which has been regularly on the table for certainly the last couple of years, but even before then,” said Hudson. “It seems to me there’s been an escalation in the debate.”
Companies may be cutting shareholder payouts more to conserve cash than as a change in long term strategy. But many businesses across Europe and the US are starting to benefit from direct cash support from taxpayers — some, such as loans and tax holidays, repayable and some, such as furloughing payments, not. This could bring a more profound shift in attitudes.
“In the context of buy-backs and dividends, a much better balance will generally be expected, and where companies received support, I think that will be particularly the case,” said Hudson. “Covid-19 is likely to produce quite broad-sweeping changes in markets.”
Already, some companies have taken actions driven by social responsibility rather than a narrow definition of their own interests.
Ineos, the privately owned UK chemical company, said in late March it would build two factories in the UK and Germany in under 10 days, to produce hand sanitiser free for health services. They opened on time, and it later added two more plants in France.
Luxury goods groups LVMH and Kering, having initially planned to use the French government’s financial support for furloughed staff, were reported by the Financial Times to have reversed course after their competitors Hermès and Chanel vowed to manage without aid.
The public is particularly aware at the moment of social inequality — which the pandemic has not only highlighted, but exacerbated. “The disparity in health [impacts] between people of colour and Caucasians is huge,” said Kenning. “So many women are thinking they have to leave their jobs because they can’t balance everything, including childcare. Women are getting laid off more, because of the sectors they work in, and because they’re not in management. That will still hurt us 10 years from now.”
Lockdown measures are particularly hard for those in cramped accommodation or suffering from mental health problems.
“The financial credit crunch put [the questioning of shareholder primacy] on the table, I think because of the shock of that event in itself and also what happened afterwards,” said Hudson. “So for example the large number of food banks still in use, well over a decade since that crash, is evidence of structural inequality.
“And the Covid-19 situation has really just thrown into light the vulnerabilities running through many sectors of society, so I think it reinforces the questioning of the shareholder primacy model and the conventional capital markets model, where the focus tends to be on the shorter term.”
Charting the response
For investors to put this rising awareness into practice, however, they need information.
ESG analysts are trying to monitor how companies are dealing with the coronavirus crisis.
The team at Morgan Stanley led by Jessica Alsford is tracking how firms handle employees, customers, suppliers, society and shareholders.
They argue that a company treating its stakeholders, other than investors, well, far from being a drag on financial returns, “can influence long term performance and returns, via factors such as employee engagement, corporate culture, brand loyalty, and ‘licence to operate’.”
The analysts are watching whether companies cut back on dividends, but also whether they carry on paying top management well, while cutting staff pay or making people redundant. They observe: “the directional changes in pay ratios of executives to average labour costs are likely to be under scrutiny”.
Morgan Stanley also warns that, with government budget deficits set to balloon even larger than after the 2008 financial crisis, “We expect investors to require corporates to demonstrate they are paying their fair share of taxes.”
Up to now, few investors’ social consciences have been strong enough to demand companies pay more tax.
The analysts see companies as having done little to protect their suppliers, but much more on reducing payouts to shareholders, especially in Europe.
“Many share buy-back programmes have been suspended, and our strategists see significant risks to dividends in the EU and US,” they said. “The risk in Europe has included unprecedented regulatory pressure, which has been absent in the US thus far.”
However, for all the talk of moving towards a stakeholder model, some companies may not have been taking care of employees sufficiently.
According to The Guardian, in the US, Amazon workers have complained that they have not been given enough face masks, the company did not implement the regular temperature checks it promised at warehouses, and they have been refused paid sick leave.
Meanwhile, the Los Angeles Times reports that at least 15 airline workers died of Covid-19 between April 5 and 13, with the true number of deaths likely to be much higher. Flights have continued to run, even though this may expose staff to risk. To benefit from a government bailout, carriers must maintain baseline service levels.
Nia Impact Capital has produced an impact report on how its portfolio companies have supported the Covid-19 relief effort. One surprising name on the list is Tesla. The electric car maker has said it has delivered ventilators to hospitals and is working on repurposing car parts to support the demand for ventilators.
However, Tesla has come under fire for years over the erratic behaviour of its co-founder and CEO Elon Musk.
“Governance-wise: very tricky,” said Hull. However, she says Nia has tried to engage with Tesla and filed shareholder resolutions, rather than divesting. “We give them a little bit of slack because the solutions are so interesting and innovative,” she said.
The ‘S’ of ESG
In many quarters, the idea is suggested that the coronavirus will bring a change in emphasis between the three pillars of ESG — a greater emphasis on the social.
Some who have long resented investors exerting pressure on environmental issues may see this as an opportunity to push back, telling them to direct their efforts elsewhere.
But responsible investors are unrepentant. Rather, they see the pandemic as clarifying for the wider world the proper balance and inter-relation of the three issues.
“There’s a time in the news cycle to talk about these things, whereas we didn’t have the media on a lot of the egregious things as far as the ‘S’ in ESG [was concerned] before,” said Hull. “Governance and how you treat your employees really matter and it mattered before. Especially when we go remote [working], you need to have a really good company culture.”
For Kenning, “Whereas ‘E’ and ‘G’ were front and centre, now ‘S’ is. It doesn’t mean we discount ‘E’ and ‘G’ — it just means people are front and centre. We’ve said all along — climate change impacts people at the base of the economic pyramid, more than those at the higher end.”
The virus has helped bring to public prominence issues ESG investors have emphasised for years, without feeling that they were much listened to.
Gender is one of them. Women leaders — whether of countries or companies — are seen as having been particularly good at emphasising the social needs of staff and customers. “Of course, all men can do this,” said Hull, “and yet the traits we’re seeing with women leaders and diverse leaders are that they are really good at communicating.”
Nia’s Global Solutions fund only invests in companies with women in positions of leadership. It has returned 6.8% on an annualised basis since inception, beating the MSCI ACWI Investable Market Index, a global equity index, but lagging the S&P 500. In the first quarter, its losses of 17% outperformed both those indices, perhaps helped by its aversion to fossil fuels. The S&P fell 21%.
Kenning said the small, large and midcap strategies she advises clients on were outperforming traditional benchmarks like the S&P and Dow Jones.
Resilience in fashion
Another word dear to the hearts of ESG investors, which is now trending in mainstream circles, is resilience.
The crisis has exposed the poor preparation of many national health systems, but also the vulnerability of many companies’ operations.
For decades, the mantra in industry has been to have the leanest operation possible, with low stock and ‘just in time’ management of supplies and production. That is fine in optimal conditions, but very prone to disruption.
“One discussion I see regularly, with our clients, is the vulnerability of long supply chains, the advantage of having resilient local and global production systems, so that you can switch between them when things get difficult,” said Hudson. “I haven’t yet seen firms making strategic shifts in that direction, but I think it’s still too soon. I’d anticipate that thinking strategically about that kind of thing will come next.”
This is the kind of management decision which has to be more than just a soundbite, or even a virtuous detour, like Ineos’s move into hand sanitiser. It goes to the heart of how a company plans and runs its operations, and has financial implications for working capital.
ESG investors will be on the lookout for companies that are taking these priorities on board, and those that are not.
Climate concern: down or up?
While the coronavirus has helped bring some long-established ESG concerns to the fore, as well as raising new ones, it has also pushed others into the background — above all, climate change.
Until Covid-19, everyone in responsible investing was worrying hardest about climate change. It clearly has not gone away. The fact that lockdowns have cut emissions sharply is encouraging, but it will not even scratch the surface of global warming if the economy goes straight back to its former ways.
For the time being, that looks likely. With oil prices plummeting, US president Donald Trump has asked his administration to come up with a plan to help producers.
Hull argues against this. “If you don’t have a viable business model that’s going to move forwards, why rebuild that now? I think this is a time to shift,” she said. She suggested instead investing in solar power.
That does not look likely, politically, especially in the US. Governments are likely to be desperate to restart any kind of economic growth, clean or dirty.
But governments are not the only actors. “I think the private investor capital will lead the way and government will follow,” said Kenning. “There’s a huge opportunity to move from commercial real estate, parking lots, warehouses to energy storage, affordable housing, commingled spaces, healthcare, telemedicine, vaccines, biotech.” Remote working technology, cybersecurity and resilient food supply are other industries ripe for an investment boom.
“There are more pandemics coming — this is not going to be a once in 100 year event,” Kenning added.
While it may be more difficult to talk about the climate while hospital intensive care units are bursting, ESG experts are adamant that there is no clash between the two issues.
The climate is “a social issue that happens to have the environment embedded all the way through it”, Hudson argues.
On the contrary, by highlighting the pain society can suffer from natural phenomena — and the strength of response that is possible — Covid-19 could strengthen the hand of environmentalists.
“Covid-19 has revealed weaknesses and inequalities in society: it’s hardest on developing countries and the less well off,” said Hudson. “The effects of climate change will also follow that pattern.”
This realisation could lead, she hopes, to a more rounded climate debate. “Climate change is not just an environmental impact, it’s a social issue,” Hudson said. “Political recognition of that has taken the form of a debate around the Green New Deals, which were being talked about some time before Covid-19 happened. And it seems to me that ideas like that may well come up again.”
The linkage is apparent even in day-to-day social problems. In London, levels of nitrogen dioxide on some of the busiest roads have roughly halved due to lockdowns, according to mayor Sadiq Khan.
This is a side benefit of the corona crisis, but this respiratory disease also makes it even more urgent than before to improve air quality.
“There’s a further opportunity here to join the dots and maybe even connect that to climate change, so you solve several problems with one strategy,” Hudson argued.
For responsible investors, the coronavirus demonstrates more fully than ever why their approach is important. Asked whether ESG needed to change as a result, Kenning said: “I don’t think we need to change it — we might need to enhance it.”
As she encapsulates the present upheavals: “This is a precursor to climate change — it’s us on training wheels.”
Believing that the virus will bring about a wholesale reformation of the investment industry is optimistic. There is a risk of confirmation bias when spotting a trend that you thought should happen all along.
For its proponents, a stakeholder model of capitalism — more resilient, imbued with longer term thinking, and more concerned with social justice rather than just financial gain — is self-evidently preferable. Yet there could still be fierce resistance.
The political fallout from the pandemic is unknowable. It may give new life to nationalism — countries have already closed borders and are now bickering over issues such as European solidarity and China’s responsibility for the virus.
Such a trend could accelerate the domestication of supply chains, but make dealing with global problems like climate change more difficult.
Still, whether you see the role of ESG investment as changing the world, or simply forecasting it, the over-riding import of the virus has been to bring home how interdependent countries, companies and people are.
“What you do in London affects me in Denver,” said Kenning. “Here’s the reality of the new normal — no amount of money can buy you out of it.”