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Is there an ESG silver lining to Covid?

The pandemic has certainly not dampened enthusiasm for sustainable investing.

In the US, for example, Morningstar reported almost $10bn (€8.5bn) of inflows to sustainable open-end mutual funds and exchange-traded funds in Q1 2020 – over half the total for the whole of 2019.

Of course there is always an argument that money follows transitory themes and because ESG portfolios avoid the oil/energy sector – then relative strong performance (as we have seen in recent months) is a given.

But is there more to the story than ESG funds simply doing better (and attracting greater interest) because they conveniently don’t invest in hard-hit sectors?

Philippe Zaouati, chief executive at Mirova, an asset manager specialising in sustainable finance, insists there is. “We have seen outperformance against the benchmark for several years – with last year a particularly good year. There is a Covid impact – but we were well positioned anyway.”

Oil pressure

Since the beginning of the year, the pandemic has led to oil price slumps and Zaouati does not see this a short-term pricing anomaly with ‘normalisation’ – so to speak – soon reversing this trend.

“I think we are witnessing a cultural change. Covid is a long-term crisis and it is a crisis that is happening at a time when we need to decarbonise the economy. Oil companies’ capex in the near future is going to be low and the sector at a global level is already at a plateau – it won’t go up strongly again.”

Which begs the question will we ever see a return to a high demand for oil?

After all, the EU Green Deal is spearheading a lot of the recovery efforts and it is prioritising infrastructure and investments that don’t target oil and gas sectors.

French and German policymakers are pushing for greater cooperation, aiming to use economic recovery to accelerate change specified in the Green Deal.

But this forward thinking is not mirrored in the US where Covid has been used as a smokescreen to scrap around 100 environmental regulations.

While at face value this appears alarming, Zaouati suggests context is everything here. “In the US you have to differentiate between politics and business. Yes, there is government regulation that has impact on the climate but at the same time all the big US banks are committed to moving money into green finance.”

Rather than being concerned about contrasting ESG commitments between Europe and the US; Zaouati is more worried about the contrast to countries like Brazil and specifically China.

“In China what we hoped would be a move towards a more open economy; has turned out not to be. Green finance in China has a very long way to go and when you talk about the ‘governance’ aspect of ESG, there remain major concerns.”

When it comes to companies embracing sustainability or merely paying lip service to it; much depends on the level of transparency. Once again this goes back to effective governance and commitment at senior level.

The integration of sustainability into business models is, to some extent at least, becoming the ‘new normal’. Zaouati says that Europe is leading the way here with greater transparency in both corporate governance and regulation.

ESG in greater focus

According to a report in Forbes, the UN Global Compact (a non-binding United Nations pact to encourage businesses  to adopt sustainable and socially responsible policies) and the UN Principles for Responsible Investment (PRI), experienced an above-average increase in membership and a spike in engagement as a response to Covid.

Both organisations have seen a been doubling down on innovation, decarbonisation and the building up of capacities to better manage ESG factors.

The fact that these organisations saw increased engagement after the 2008 Financial Crash too, shows that crises tend to act as wake-up calls.

Covid and its impact stresses the point that markets do not operate in isolation but are heavily linked to societies and the natural environment.

This applies as much to climate change as it does to pandemics.

And when it comes to risk management in what is an unprecedented crisis, Zaouati believes that those companies that have prepared for climate change and actively supported sustainability will be best placed to weather the storms.

“We continue to see a move away from shareholder value to stakeholder value. ESG finance has made the point for some time that companies are not isolated from the environment and that the focus needs to shift to all stakeholders and much clearer governance.”

Vincent Juvyns, global market strategist at JP Morgan Asset Management, makes the point that the crisis also demonstrates that embracing ESG is not a vague distant goal, but something that immediately strengthens the resilience of our societies and companies.

But, he adds: “We need to recognise that this crisis will likely delay many policy initiatives in this field, as the priority for governments is now clearly to address the health and economic consequences of the pandemic.”

He concludes that for investors, there is no time to waste.

“At a time when governments need to reorient their focus and financial efforts towards crisis management, it’s up to private investors to step in and fill the gap to ensure that their long-term savings help to support our long-terms goals.”