What effect has the global pandemic had on the trend known as ESG investing? Is it a net plus for the idea or has it actually pushed the concept backwards? If the focus in the coming months is on how to raise growth, create jobs and pay down huge debts, can the world afford some of the ideas associated with ESG. This article examines such points.

Is the pandemic the end of environmental, social or governance-driven investing or a new beginning? It might seem a bizarre question n view of the fact that the virus has highlighted concerns over food hygiene, the treatment of animals and its affect on humans. However, another concern is the accountability – or lack of it – of governments, NGOs, and some private firms. The impact on civil liberties from the lockdowns is also worrying, as is the divisive impact of COVID-19; some people have continued to work, some were made redundant and others have had to close their businesses. Even so, when the pandemic struck, it did appear, as far as this publication could tell, to put a few established ESG themes in the shade for a few weeks. And to be frank, that was possibly not a bad thing. To a certain extent, ESG commentary had become stale and needed freshening up. 

To discuss what the pandemic means for the ESG approach are Indranil Ghosh and Shelly Goldberg. Goldberg is the founder and principal of Invest-With-Purpose, an environmental sustainability investment management and strategy consultancy. With more than 20 years of experience in structuring and managing portfolios, she runs an environmental sustainability consultancy and investment management practice. Dr Ghosh is an MIT-trained scientist, a sustainable investor, author, and a strategic advisor to governments and leading global corporations. Prior to Tiger Hill Capital, Dr Ghosh was head of strategy at Mubadala, Abu Dhabi’s Sovereign Investment and Development Fund, working in senior roles at Bridgewater Associates and McKinsey & Co.

The editors, as ever, don’t necessarily endorse all views of guest contributors and invite readers to jump into the conversation. We are grateful for this contribution to debate. Email tom.burroughes@wealthbriefing.com and jackie.bennion@clearviewpublishing.com

Five years ago, many people dismissed environmental, social, and corporate governance investing as a fad because it put purpose alongside profit. But today, ESG investing seems to have become mainstream as global flows into sustainable investing are worth upwards of $4 trillion annually. Furthermore, as the COVID-19 crisis mounted in Q1 2020, investors poured $45.6 billion into ESG funds while $384.7 billion flowed out of the overall fund universe.

According to the UN, the funding gap to meet the Sustainable Development Goals is at least $2.5-3 trillion annually in developing countries alone. We think it is more like $5 trillion globally. Plugging this gap from the public purse would require a 20 per cent increase in the global tax base, which stands at about $25 trillion today. Clearly, this is not feasible. However, steering a small portion of global private wealth, which stands at $200 trillion globally, into sustainable investments could address the world’s development challenges.  

Fortunately, investor interest in ESG opportunities has grown steadily as evidence continues to mount that the pursuit of societal benefits does not compromise financial returns. In line with an expanding body of research showing that companies with robust ESG practices outperform their benchmarks, Blackrock’s latest study shows that 94 per cent of widely-analysed sustainable stock indices outperformed their benchmarks in Q1 2020.

As public attention zooms in on ESG issues due to the COVID-19-induced economic crisis and protests following the killing of George Floyd, many investors are frustrated by the lack of additive impact generated by ESG investing to date. Witness the public backlash against Amazon when it emerged that, in spite of high ESG scores, many of the company’s US warehouse workers have died from COVID-19 - a tragedy that its employees attribute to poor working conditions.

Problems with ESG investing
Several challenges with the current ESG investing framework have thwarted the impact many investors intended to achieve. First, investment flows trump ESG fundamentals. Approximately 95 per cent of sustainable investment flows are allocated to passive ESG funds that rarely engage with company boards to influence critical changes like carbon emissions or diversity. ESG funds also tend to flow into large corporations which have many alternative sources of capital. But it’s often the multitude of smaller disruptive businesses at the lower end of the enterprise pyramid - those with direct, pure-play ESG initiatives - that could make most meaningful impact.

Second, ESG investors are held back by the lack of standards in measuring and reporting ESG outcomes. While a company may have the right indicators to check the rating agency boxes, it may not achieve the desired outcomes. Combined with the lack of a widely used industry standard for ESG metrics, the door is wide open for corporations to “ESG-wash” their corporate social responsibility metrics. Some heavyweight investors such as Blackrock are rallying behind high-quality reporting guidelines like the Sustainability Accounting Standards Board (SASB) and the Task Force on Climate-related Disclosures (TCFD), but we are a long way from standardisation across ESG ratings.

Third, the universe of active ESG investors - like Trium Capital and BNP Paribas’ Energy Transition Fund, who engage with their investee companies to improve their ESG performance - has been small, albeit this strategy is gaining traction.

Fourth, ESG investing, particularly with its focus on large-cap companies, has often been viewed as a means of influencing gradual, long-term improvement in corporate sustainability practices. However, as the economy is increasingly buffeted by climate catastrophes, pandemics, and other shocks, the urgency for ESG investing to address short-term socioeconomic priorities is likely to be dialled up.
 

New beginnings
At a time when the costs on society from loss of life, prolonged economic hardship, and social unrest are becoming increasingly palpable, ESG investing must be transformed from a futile administrative exercise to a means for driving much-needed system change. After all, a sustainable and resilient system is the best way to drive up overall market returns.

Before the pandemic, climate change was the single biggest focus for ESG investors. However, the balance is now tilting towards the "social" pillar since the pandemic has amplified pre-existing social problems that were blighting our societies. However, to amplify direct impact and exert greater control over their investees, ESG investors should also consider ramping up active engagement with large-cap holdings, as well as deploying more capital to sustainable infrastructure, corporate credit, and smaller disruptive companies through private equity, venture capital, and crowdfunding.

On the active engagement front, asset manager Trium Capital targets companies in high emissions industries like oil and gas, utilities, and mining and works collaboratively to help them transition to higher growth, lower emission, ESG leaders. Some leading pension funds are also waking up to this trend by organising collective action. The New York State Common Retirement Fund, the third largest US public pension fund, plays a leading role in Carbon Disclosure Project’s Carbon Action initiative of 304 investors representing $22 trillion that lobbies for company action on emission reduction and energy efficiency.

Sustainable infrastructure offers a good fit for institutional investors such as pension funds since they provide long-term, contracted cash flows to help with matching pension liabilities and offer an alternative to holding hydrocarbon assets which are at risk of becoming “stranded” should tighter carbon emission regulations be introduced.The  Canadian Pension Plan Investment Board, for example, has formed a joint venture with Brazilian energy generator Vortarntim Energia to fund the development of Brazilian wind farms.

Corporate credit may be more effective than equity in driving ESG specific outcomes and can be tied to loan covenants and conditions. By contrast, it is more difficult to implement such conditionality and even attempts at active engagement can be diluted by new share issuance or share buybacks.

Smaller companies face a measurably constrained funding environment, which has only been exacerbated by the crisis. Funding for US start-ups fell by 16 per cent in Q1 2020 compared with Q4 2019. Furthermore, VC-funded start-ups do not qualify for support under current US stimulus programmes for small businesses.

Capital infusions into smaller companies and start-ups - especially those directly targeting sustainability issues - are much more likely to have a rapid additive impact because many would otherwise disappear for lack of capital. A new breed of VC and PE funds, such as Berlin-based Moonfare, offer exposure to smaller, disruptive ESG companies to mass-market investors which may lack access to the premier funds. Moonfare sets its ante at €100,000 ($118,594) which can phase in over four years spread over a number of funds.

However, ESG investors cannot bring about positive system change by themselves. This will require a partnership between investors, businesses, and governments working together as “Engaged Societal Guardians” - perhaps a paradigm for the “New ESG”. Since the COVID-19 crisis has put societal repair on a critical path to survival for all three groups, there seems to be an opportunity to fashion a new collaborative model borne out of enlightened self-interest.