The Covid-19 pandemic has shown how important environmental, social and governance factors are when making investment decisions, according to analysts.
Calls for an expanded role for ESG factors in investment portfolios came as a report from S&P Global suggested investment funds that make decisions based partly on ESG criteria have outperformed the S&P 500 during the recent market crash.
Across 17 such exchange-traded and mutual funds, 12 had lost less value than the 13.7 per cent shed from the S&P 500, with the best-performing suffering only a 5.4 per cent loss.
The disparity was attributed in the report to the decreased level of exposure to the fossil fuel value chain in ESG funds. This left them comparatively well protected against fluctuations in the oil market, driven by the ongoing price war between Russia and Saudi Arabia, and the collapse in demand as populations across the world attempt to stay inside.
We can show, very tangibly, that integrating ESG-measures into your portfolio does not worsen your risk-return profile. It’s not that it’s a constraint, it’s more an opportunity
Carlo Funk, State Street Global Advisors
Research carried out by Fidelity International found similar results. While the S&P 500 fell 26.9 per cent between February 19 and March 26, companies with an ESG rating of A on Fidelity’s metric performed on average 3.8 per cent better than the market, while companies with the lowest score, E, performed on average 7.4 per cent worse.
ESG-investors 'vindicated' by market moves
Masja Zandbergen, head of sustainability integration at asset management company Robeco, said ESG-conscious investors have been vindicated by the recent market moves.
“The healthcare industry and tech industry are doing quite well during this crisis, but there are others, and they are typically the industries with sustainability issues, which are not doing that well,” she said.
Ms Zandbergen argued that the response of national governments to coronavirus has significant ESG implications.
She continued: “Now is an important time to take action, and it’s probably easier in a recession to take action against the older, more polluting industries – to show some leadership on [ESG] issues. Let’s take the recession as an opportunity to combine economic stimulus with environmental action, on healthcare and on social issues.”
While governments may take action as we emerge from the crisis, a paper published in April by State Street Global Advisors argued that the pandemic itself has profound implications for our understanding of ESG.
Investors must now weigh factors like access to and affordability of vital products like medicine, labour practices, employee health and safety and overall governance – previously sidelined as ESG considerations – into their day-to-day decisions.
Carlo Funk, SSGA’s head of Emea ESG investment strategy, said that in conversations with asset owners, “you hear all the time that it’s not their mandate to enforce ESG”.
“With the social part particularly, it’s perceived as a qualitative, vague assessment,” he continued, countering that “how a company addresses its ability to ensure broad access to its product and services” is now a key driver of performance.
Mr Funk said climate-related data do not offer the same clarity: “We can show, very tangibly, that integrating ESG-measures into your portfolio does not worsen your risk-return profile. It’s not that it’s a constraint, it’s more an opportunity”.
Scheme-specific conditions to determine success
While the Covid-19 pandemic is an almost unprecedented phenomenon, experts predict it will be schemes' underlying health conditions that determine how they emerge from the crisis.
Speaking on the health of defined contribution funds, Alistair Byrne, managing director and head of Emea pensions and retirement strategy at SSGA, told Pensions Expert: “If you’ve got your scheme members in a well-diversified default fund, that default fund has either a life-cycle or a target-date structure, which means people have the right amount of risk for their stage in life.”
He said younger members can weather volatility associated with equities, while older members should be well derisked.
“That kind of structure is still the right one and will be working today, and it will work in the future,” he said.
How will DC stand up to Covid-19 pandemic?
The Covid-19 emergency is taking its toll on the defined contribution savings space, with master trusts reporting small numbers of employers missing contributions and businesses grappling with the pensions implications of furloughing and redundancies.
Diversification, too, is important. Mark Hodgson, partner at Gatemore Capital Management, said the value of spreading risk has been weakened following the global financial crisis, with schemes “making money pretty much anywhere because assets were on central bank steroids”.
By contrast, defined benefit schemes that were poorly funded before the crisis will be suffering more during the market crash.
Paul McGlone, partner at Aon, explained: “If you are, say, a poorly funded scheme, why are you poorly funded? It’s probably because your sponsor can’t afford to put more money in.
“And one of the consequences of being a poorly funded scheme is it probably means you’re seeking more return, you’ve got more equity exposure and you’ve got lower hedging than you’d like to have."
The government insists it is not intervening in pension scheme investment strategies with a climate change amendment to the pension schemes bill introduced earlier this month.
