June 26, 2020
Environmental, social, and governance (ESG) investing has drawn considerable investor attention over the past few years. Morningstar1 reported that 2019 represented a record year of flows into ESG-related funds in both Europe and the United States. Along with this increased investor interest, Macquarie Investment Management has continued its commitment to sustainability, such as enhancing ESG efforts through new analytical and performance measurement tools for our investment teams to integrate into their investment processes. Yet, as the world continues to seek the most effective ways to deal with the COVID-19 pandemic, investors have questioned if there has been a shift in the relative importance of ESG issues when assessing the risks and opportunities of current and prospective investments. In other words, has ESG lost some of its relevance during the pandemic – or does the crisis make it even more important?
There are currently two schools of thoughts on this subject. One is that with the considerable toll that the pandemic has taken from both a societal and economic standpoint, seemingly more distant and lower-priority issues such as climate change will take a back seat, especially as the financial assets needed to make changes appear more scarce.
The other thought is that people have been ignoring warnings about a global pandemic for quite some time and the lack of preparedness to deal with the issue is a critical factor in the problems the world is now facing. The same logic can be applied to longer-tail issues such as climate risk, where a potential crisis may similarly be lessened with nearer-term action.
An eye to the long term
Macquarie Investment Management’s view on the relative importance of ESG in the investment process has not changed as the result of the pandemic. As Lotte Beck, ESG manager for Macquarie’s Luxembourg-based ValueInvest Global Equity team, put it, “Our approach to ESG has always been to look at it as a stamp of quality. Stable, quality companies usually also have a higher level of ESG management and vice versa.”
Macquarie Investment Management’s specialized, independent investment teams are focused on delivering long-term, consistent results for our clients and the majority of our investment teams employ a fundamental approach toward identifying and assessing securities. Inherent to their investment processes is an in-depth analysis of economic, competitive, and other factors that may influence future revenues and earnings of the issuer of the securities, including factors that have been identified as material from an ESG perspective.
Parsing out “E,” “S,” and “G”
This emphasis on materiality may result in a shift in focus regarding the consideration of ESG factors when evaluating potential investments. In the past few years, the “E” in ESG – environmental – has taken on ever increasing importance as investors have assessed the risks of climate change and its potential effect on a company’s future revenue and expenses.
An example of this is the impact of global warming on the future crop supply for food processors and other industries that rely on these vital raw materials. In a 2019 report, the US Department of Agriculture’s Economic Research Service found that if greenhouse gasses are allowed to continue to increase, US production of corn and soybeans could decline as much as 80% over the next 60 years (source: Wall Street Journal).
Of a more immediate nature is the dramatic increase in wildfires in recent years that many attribute to climate change. Barry Klein, utilities analyst on Macquarie’s Global Listed Infrastructure team, has regularly traveled to California to gain insights into the impact of utility-caused wildfires, assess the response of utilities, and meet with legislators, regulators, and management teams. “It’s important, from both an investment and an environmental responsibility perspective, that we gain a full understanding of the response of the different parties, and how seriously they are taking this growing issue,” Klein said.
While environmental factors remain important risks to consider, “S”, or social factors, are also taking on increasing importance as investors assess the risks of COVID-19 on individual companies. Workplace health and safety is a social factor that the Sustainability Accounting Standards Board (SASB) has identified as being important to many industries. Adrian David, senior credit analyst on Macquarie’s Fixed Income Global Credit Research team, pointed out that workplace safety has historically been a big focus for riskier industries such as mining or energy, Now, challenged by the rapid spread of the virus, more companies outside these sectors are considering how they can operate while providing a safe environment for their staff.
Lack of a safe environment for workers had a considerable impact on several meat processing companies in the onset of the pandemic in 2020. An inability to readily identify COVID-19 infections and promote social distancing resulted in plant closures and the corresponding loss of a substantial percentage of the companies’ meat processing capacity and the revenues associated with it. Stakeholders are also keeping a focus on other social issues such as companies’ actions in terms of how they treat their employees, and many companies need to assess the short-term cost savings of employee layoffs or pay cuts against the longer-term implications of needing to attract and retain talented employees once economic conditions improve.
While there are many risks associated with the COVID-19 crisis, potential opportunities exist as well. Companies involved in vaccine or treatment research have experienced substantial stock price increases as a result of initial positive developments. Similar to any other new product introduction, analysts need to thoroughly consider the costs associated with developing these new products as well as the impact of pricing decisions when determining the full market value impact from these potential solutions.
The “G”, or governance aspect of ESG, has always been an important area of focus for investors and will continue to be in the current environment. Steven Catricks, senior portfolio manager on Macquarie’s US Small Mid Cap Value Equity team, noted “how companies address governance issues such as executive compensation will be an important determinant of management quality. Share buyback and dividend policy will also take on greater relevance as stakeholders assess managements’ ability to be effective stewards of capital.”
ESG only a subset of fundamental analysis
The above-mentioned issues are some of the many on which our investment teams focus and reinforce the message we’ve conveyed many times before – that ESG analysis and integration present just a subset of overall thorough fundamental analysis. Investors appear to agree that ESG issues remain paramount even in the face of dealing with the global pandemic. Morningstar reported that sustainable funds globally attracted an estimated $45.7 billion in net flows during the first quarter of 2020 even as the overall fund universe suffered $384.7 billion in outflows2. Summarizing the impact of the pandemic on ESG, Åsa Annerstedt, a portfolio manager on the International Value Equity investment team, said, “COVID-19 shone the light on the importance of ESG. It will change industries for good, if humanity is wise enough to learn and adapt.”
Commitment to sustainability
Macquarie has taken an active role in the global debate on sustainability, green finance and similar issues, harnessing private capital to address challenges such as reducing carbon emissions and adapting to climate change. Macquarie has a longstanding commitment to harnessing private capital to address these challenges, continuing to both incorporate these types of investing principles, and align with sustainability-oriented initiatives and organizations.
One such organization is the Sustainability Accounting Standards Board (SASB), which has a mission to establish standards that assist companies in disclosing financially material, decision-useful sustainability information to investors. Macquarie Investment Management, as a member of the SASB Alliance, helps promote standardized sustainability disclosure and effective ESG integration into investment practices. Our investment teams have found many commonalities between the ESG factors that SASB has identified as material for a given industry and the fundamental and quantitative factors that the teams use in analyzing a company’s investment prospects.
1Morningstar, Jan. 10, 2020, “Sustainable Fund Flows in 2019 Smash Previous Records.”
2Morningstar, May 14, 2020, “There’s Ample Room for Sustainable Investing to Grow in the U.S.”