ESG as an equity vaccine

This article is part of our Earth Week special report.

COVID-19 struck corporate sustainability with such precision and force that few average portfolios came out unscathed. ESG holdings, however, seem to have held up better than the rest, and have outperformed, and we argue that the main outperformance is yet to come as the market settles into a new ESG-sensitive equilibrium. 

“The COVID-19 pandemic has profound implications for ESG and responsible investment,” said Vicki Bakhshi, Director of Governance and Sustainable Investment at BMO Global Asset Management, in a recent webcast hosted by the Responsible Investment Association (RIA), pointing out that now, there is greater attention on ESG issues.

Point of attack
As we were hitting all-time highs, the writing was on the wall, and when it came to our portfolios, the pandemic hit points of weakness.

“2020 opened with high-profile announcements from some of the world’s largest institutional investors, including BlackRock and State Street, that they would increase their focus on ESG, including proxy voting more actively in support of ESG priorities. Something we found notable in this context was the extent to which institutional investor support has solidified behind the ESG disclosure frameworks that are specifically oriented towards the capital markets audience,” adds Rebecca Zentner-Barrett, Associate at ESG Global Advisors.

You could immediately see who was (and wasn’t) prepared after the pandemic struck. Boards were immediately swept up with crisis management issues around staff and stakeholders, says Bakhshi, as brands faced off with urgent short-term decisions and their long-term reputational effects.

COVID-19 made its mark on all three pillars – Environmental (E), Social (S), and Governance (G) – of ESG. But what happened to the social side of stocks was something special.

We are all the ‘Social’ pillar
2020 started with pipeline protests, catching the most well-run and responsible companies of the modern world off-guard. The relevance and investment case of these and other social issues may not have directly impacted us in a meaningful way, but the pandemic changed all that, putting social considerations front and center.

“The materiality of “S” factors has been demonstrated in the most graphic ways possible,” says Michelle de Cordova, Principal at ESG Global Advisors. “This factor within ESG has often been overlooked or misunderstood, but the last few months may change that. If we think back to 2010, when the provincial legislature mandated the Ontario Securities Commission to review ESG reporting standards, developing guidance for governance and environmental disclosure was prioritized over social disclosure. Ten years on, there’s still no widely accepted framework for social disclosure specifically oriented towards the capital markets, even for the “S” issues that are almost universally financially material, such as human capital management,” she points out.

A still-developing standard for social management is yielding much more for early adopters. There’s greater attention to how companies treat staff, suppliers and the community, from financial or mental health support for employees, to early payments for suppliers, or corporate contributions to public causes, says Bakhshi.

Signs of strength
When it comes to finding the most socially conscious companies, de Cordova notes that there aren’t frameworks to use as benchmarks – but some initiatives with institutional investor participation have been exploring the gap (such as the Human Capital Management Coalition).

“At the same time, COVID-19 has highlighted and greatly amplified many of the everyday social risks and opportunities associated with human capital management - workforce health and safety, employee engagement, accommodating caregiving responsibilities, dealing with layoffs, and cybersecurity protocols for remote workers,” says de Cordova. “How well companies deal with these issues will likely have lasting brand and reputational impacts – and how well companies dealt with these issues before COVID-19 is likely to influence how well they deal with them now, in an emergency.”

The world of ESG investing post-pandemic will come with new clues and pitfalls. For example, donations of soap, sanitizer, bleach and food from Unilever (UN), were well-received, says Bakhshi, while some pharmaceutical and biotech companies have been accused of profiteering from the crisis.

It’s also important not to lose focus of the other ESG factors, says de Cordova. “In ESG, everything is connected.” For example, executive pay and compensation in the governance department were both emphasized by Bakhshi and de Cordova as potential risks now under greater scrutiny.

Don’t forget climate change
And the relationship between the environment and the economy is stronger than ever. “One very direct connection is the emerging research that shows a correlation between levels of air pollution and higher death rates for those infected with COVID-19, adds de Cordova. “Climate change and health are also connected: the World Health Organization estimates that climate change could result in more than 250,000 additional deaths annually between 2030 and 2050.”

“While COVID-19 has required an urgent and global response, the issue of climate change still remains of critical importance to the economy, particularly in the long-term,” agrees Sarah Keyes, Principal at ESG Global Advisors. “Much has been written on the connection between COVID-19 and climate change, further demonstrating the importance of this topic, even during a global pandemic. Investors continue to reinforce climate change as a priority ESG topic, with several large Canadian investors re-affirming their commitment to addressing climate change issues in their updated 2020 proxy voting guidelines.”