Impact and ESG investing under Covid19

Today's article is about a topic I find tremendously exciting, coming from a business background. For those who are not familiar with the term, impact investing is defined as a type of investment (across many asset classes), that aims at providing a financial return as well as a social impact, for instance in the form of employment to a typically marginalized community. However, impact investments are not the only way to try to make profit and better intentions merge. A very popular tool to assess companies or funds you might have heard about are the ESG ratings. These assess the environmental, social and governance risks and result in a straightforward rating ranging from AAA (leader) to CCC (laggard) (these are the definitions used by the platform MSCI).

Earlier in 2020 the world's biggest asset manager, BlackRock, announced in a highly publicized statement that it would put ESG factors "at the heart of its strategy". Clearly, BlackRock wants to show its leadership position by echoing an increasingly popular sentiment that large companies need to make a difference and not just profit for its shareholders. With companies like Walmart having higher revenues than the GDP of Austria or South Africa, many feel like businesses need to step up and be more involved in having a social impact with their work.

Additionally, sources such as the Financial Times and the UK investment firm Charles Stanley state that investments with a sustainable/ESG focus outperform the wider market, especially in the long term, giving BlackRock's strategy also a clear financial rationale. However, since ESG-rated investments have grown in popularity during the market high of the last decade, many feared that investors would drop it as soon as the first big crisis would hit, a fear that got a lot more real, as the financial and economic impacts of Covid19 started to have an effect. The good news is that investors do not consider factors others than the basic risk/return tradeoff as a "nice to have" anymore, but instead see higher standards such as the ESG as a necessity. In fact, during these last months companies that hold themselves to higher ESG standards fared better than their peers during the pandemic. Confirming this is a report by BlackRock, claiming that 94% of a group of 32 sustainable indices fared better than their benchmarks in the first quarter of 2020. Notably, this was also the case for about 75% of these indices during other market downturns in 2015/16 and 2018.

One of the many reasons for this is that for instance firms where employees are in general treated better, operations were less disrupted by lockdowns and home office measures. A US study from July found that what particularly made a difference in performance were high environmental and social ratings, whereas the governance factors were not significant. Going back to BlackRock, their main claim is that putting ESG factors in the focus of their investments makes for a more resilient strategy, and see themselves confirmed by the positive performance mentioned earlier.

ESG as an equity vaccine?

However, a study published on August 27th by researchers from Canada, the Netherlands and the United States seems to debunk this claim, as they found no significant correlation between ESG focus and fund performance, after adjusting for factors such as industry affiliation, liquidity, leverage and more. Naturally, the scientific method of this peer-reviewed paper naturally calls into question whether BlackRock and other investors should look at their data more closely. At the same time, there are various other studies, such as one on banks' from 2016 or another one stocks' performance from 2020, who actually confirm BlackRock's claim that ESG increases resilience and thus is an effective measure to weather crises. Thus, this most recent report should be interpreted with caution and especially remind investors that enthusiasm like Morningstar's praise of ESG as an "equity vaccine" may be inappropriate. Another valuable advice they give is to not start suddenly start using ESG as the main benchmark to assess investments, at the cost of being more lenient on still very important aspects, such as liquidity and leverage.

What is the impact of this?

• The impact of this news and studies is that while naturally not being 100% unanimous, the reports of important players in the investment world and various academics seem to agree that focusing on ESG (as a complement to other factors of course) is a good strategy to perform better during crises, as this improves resilience.

• Another important aspect here is that the debate on this furthers serves to take socially responsible investments out of a niche and among widely accepted investment opportunities.

What can you do?

• You can inform yourself more about where your money is invested. Naturally, giving investment advice is beyond the scope of this blog, but there are great resources for you to find out if your money is supporting businesses with an ESG focus. Morningstar for instance is increasingly supplying information about sustainability and ESG ratings, so that is certainly a good place to start.