Covid-19: Why the ‘S’ in ESG matters

It’s difficult to fathom how much the world has changed within a matter of months. As governments around the globe launched ever more stringent measures to contain – or at least delay – the spread of the novel coronavirus, life as we knew it transformed before our eyes.

Today, a third of the world’s population is under some form of lockdown, effectively confining people accustomed to roam freely to their own living quarters. In these unprecedented times, businesses have had to adapt in an extraordinary fashion, and working patterns shifted overnight.

A few months ago, the thought of having around 25% of the world’s total working population working from home would have seem inconceivable. Remote working was a niche – some may even say it was a perk. And yet, this is the reality for many of us now, as companies had to become more innovative and (in many cases) embrace remote working just to keep their business running. Bloomberg has reported that the crisis has ‘unleashed a new sort of business creativity’. Social media apps are flourishing, with people sharing candid pictures of their new working arrangements with one another that may include children and pets as new-found colleagues.

Meanwhile, various CEOs have decided to forego some or all their salaries for the remainder of the year, while various companies have donated key medical equipment or retooled factories to produce more. For those of us who have been following the evolution of environmental, social and governance (ESG) practices across companies, it has become fairly obvious that Covid-19 has brought the ‘S’ in ESG to the fore.

Issues such as climate change and diversity have dominated the news in recent years, and this is captured within the ESG analysis completed by many investors. However, employee welfare, access to healthcare, corporate culture and supply-chain sustainability are all core ‘social’ ESG issues that have become particularly important during this pandemic.

Companies whose models were already set up for continuity in emergency and those that have embraced a change culture and adopted smart working practices have fared better in this environment, alongside companies that are deemed more sustainable.

This can be useful information for investors. Morningstar has noted that sustainable funds have held up better than conventional funds during the first quarter. Seven out of 10 sustainable equity funds finished in the top halves of their Morningstar Categories, and 24 of 26 environmental, social, and governance-tilted index funds outperformed their closest conventional counterparts.

Some of this was due to their low exposure to energy, but as mentioned by Morningstar, sustainable funds also invest in companies that rise to environmental challenges and treat their stakeholders well. In other words, these tend to be quality companies that hold up better than their lower-quality counterparts in difficult market environments.

We believe that ‘business as usual’ will not be what we return to after this crisis. Corporate supply chains, for example, are likely to change dramatically. In the past, there was a tendency to target low-cost resources, but this does not agree with the long-term definition of resilience, which focuses on having diversified and sustainable sources. Future working patterns are also likely to change, while corporate responses will become even more vital and could be a differentiator in terms of attracting talent and keeping staff productive.

Corporations and finance will continue to play a major role in future, but their relationship with their customers will change. Investors are looking at corporate behaviours in these times as indicators of corporate culture. For example, rather than encouraging healthcare companies to cash in on the crisis with the latest cure, responsible financial institutions are allowing management the opportunity to reconfigure and emerge stronger.

Indeed, some healthcare companies that have increased pricing on key drugs to battle coronavirus have been questioned, while others that have given medicine away have been hailed as responsible corporations. The impacts of these actions will be important for those companies’ inclusions in sustainability funds going forward.

There’s also another aspect to this story. The current pandemic may be the dress rehearsal for climate change rather than a disastrous obstruction of it. Measures that were recently deemed too rash in response to the climate crisis have now been deployed in yet more radical ways to tackle the pandemic. We are already redefining what are considered essential or frontline services and jobs, we are remembering the true value of health and nature.

States are making swift decisions that have an immediate impact on the lives of millions of people. In countries around the globe, we are seeing the environmental effects of a steep drop in the use of various types of transportation and industry. According to satellite observations1, two of the hardest hit countries, China and Italy, have shown a dramatic reduction in air pollution levels since lockdown measures began.

This real-time evidence of an immediate reduction in emissions can hopefully fuel arguments for more ambitious targets and regulations in the future. The pandemic provides an opportunity to assess business, government and other reactions as an indicator for preparedness in the face of potential climate-related disasters.

Covid-19 is forcing us to take a good, hard look at the vulnerabilities in our local, state, and national systems. Many are bracing for a significant impact in the financial markets, the healthcare sector, and the housing sector. If Covid-19 plunges us into a severe recession or a depression, as is being predicted, will corporations and municipalities stay true to their ESG promises?

As investors, we believe this is the perfect time to maintain the pressure and push for real change. We believe there is an opportunity here to accelerate the adoption of sustainable business models in all we do. Instead of looking at sustainability as a discount to our investment, or a cost, we have to start looking at the sustainability premium that we have seen emerge from the current crisis.

With this in mind, we are proud for Invesco to be a signatory of the open letter from the Interfaith Center on Corporate Responsibility (ICCR), urging companies to protect the welfare of their employees, customers and suppliers through the current pandemic, as well as the communities in which they operate. All of them are stakeholders who are vital to the long-term viability of these companies.