The Push for Sustainable Infrastructure

Lower carbon emissions are not going away

Has COVID-19 Made Sustainable Investing More – or Less – Important?

Photo courtesy of Macquarie Group LTD.

By BARRY GLADSTEIN/Macquarie Investment Management

Environmental, social, and governance (ESG) investing has drawn considerable investor attention in recent years. Morningstar[1] reported that 2019 represented a record year of flows into ESG-related funds in both Europe and the United States. Along with this increased interest, Macquarie Investment Management has continued its commitment to sustainability such as through new ESG analytical and performance measurement tools for investment teams to integrate into their process. Yet, as the world continues to seek 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 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 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 resulting lack of preparedness is a critical problem the world now faces. 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 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.”

The majority of our investment teams employ a fundamental approach toward identifying and assessing securities. Inherent to their investment process 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 ESG factor consideration 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.

Of a more immediate nature are 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.

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 our ongoing message – 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 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 outflows.[2] Summarizing the impact of the pandemic on ESG, Åsa Annerstedt, a portfolio manager on the International Value Equity 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.”

Macquarie Investment Management is an Associate Member of TEXPERS.The views expressed in this article are those of the author and not necessarily Macquarie Investment Management nor TEXPERS.

Sources

[1] Morningstar, Jan. 10, 2020, “Sustainable Fund Flows in 2019 Smash Previous Records.”
[2] Morningstar, May 14, 2020, “There’s Ample Room for Sustainable Investing to Grow in the U.S.”

About the Author

Barry Gladstein, CFA, leads Macquarie Investment Management’s Environmental, Social, and Governance (ESG) efforts.

BY STEFFEN REICHOLD, Stone Harbor Investment Partners

Sustainable investment assets globally reached $30.7 trillion at the start of 2018, an increase of nearly 35% in two years, according to the Global Sustainable Investment Alliance. And while the majority of these assets are invested in equity strategies, bond investors are actively participating in the growth of environmental, social and corporate governance, or ESG, investing through various approaches, including purchasing green, social and/or sustainable bonds, launching ESG funds, benchmarking against ESG indices, and embedding ESG factors into the overall investment framework. 

In our view, integration of ESG factors into the fixed income investment process is complementary with fundamental credit analysis and engagement activities with sovereign and corporate issuers. Importantly, active investor involvement can drive change and positively affect sovereign and corporate issuers by creating incentives for them to improve ESG performance and by supporting economic development through fixed income investments.

Of the primary ESG factors, governance is particularly important to bondholders due to the impact it can have on improving institutions and on the rule of law that supports economic development. From a bondholder’s view, the sovereign’s commitment to political stability and security, and the strength of the institutional framework that supports the financial sector are strong indicators for improving creditworthiness. Considerations that are particularly relevant with corporate issuers include management incentives to ensure that their actions do not disadvantage bondholders in favor of stockholders, the structure of the board of directors, and the nature of the shareholding structure, among other factors.

Social issues and environmental factors, while still relevant and important, are somewhat more narrowly applicable compared to the governance factor. For a bondholder, the ability to influence social issues (e.g., worker rights, fair pay and adequate living standards, etc.) is limited. However, where these social issues are inequitable, concerns about the stability of the country are raised, along with questions about the sovereign’s ability to service its debt. Environmental factors are crucial for sectors such as the extractive industries. Again, from a credit perspective, the ability to effectively manage environmental risks (e.g., lapses and accidents) is a key concern as the company’s approach could have significant economic implications for the company, thereby affecting its debt servicing capabilities, as well as causing potential fatalities.

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Improvements in ESG scores, particularly as they apply to governance, are often connected to better returns as the market prices in the improved fundamental (and thus lower risk premium). Therefore, the incentives for both issuers and investors to take actions to positively impact ESG scores are clear: improved ESG factors tend to be associated with lower spreads and thus better returns, benefitting bondholders; and countries and corporations that experience improving ESG scores also tend to undergo economic development and reduce their borrowing costs.

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The increasing demand for fixed income ESG products have also led to the development of tools for investors. Morningstar introduced their Sustainability Rating, which measures how well the holdings in a portfolio are performing on ESG factors relative to a portfolio’s peer group. Fixed income ESG indices have also been developed to provide a comprehensive and efficient coverage of the investable universe. For the JP Morgan ESG index suite, weights are set by scalar as determined by ESG score. For fixed income asset managers, tools that aid in analysis of ESG factors and provide better transparency are critical in managing ESG strategies.

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The views expressed herein do not constitute research, investment advice or trade recommendations, do not necessarily represent the views of Stone Harbor Investment Partners nor TEXPERS, and are subject to revision over time.

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