Confluence Philanthropy's recent virtual Advisors Forum included a panel discussion I participated in which focused on the opportunities for values aligned investors. The lively discussion explored a range of important issues related to the transition to a more sustainable economy, including the impact of the COVID-19 crisis on the investment industry and whether the ESG framework will need to evolve as a result of the crisis.
Over the past decade, ESG has emerged as a powerful force in investment thinking: not only are many asset owners requiring their managers to take ESG factors into account, but financial market regulators are inclined to make this mandatory. The outbreak of COVID-19 and subsequent lockdowns have heightened the investment industry’s focus on ESG issues. However, to avoid misunderstandings, it is time to engage more thoughtfully on how it is used by investors and regulators.
There are certainly compelling reasons for those managing money to continually improve what they do, and ESG thinking raises issues and ideas that are new for many. However, despite its creators’ worthy objectives to challenge thinking, ESG is not a foundation of investment management. Specifically, environmental and social issues are just two of the many external factors facing companies. A more compelling framework would map all internal and external issues affecting corporates.
So how can the industry avoid the dangers of applying this useful tool to the wrong task? First, ESG should be fully incorporated into mainstream investment processes as a proxy for ‘smarter thinking,’ particularly taking a longer-term, broader view. Second, materiality is vital: investment analysis is complex, so analysts should focus on what’s important and not waste their time producing tick-box reviews of every conceivable risk issue. Third, and probably most importantly, regulators should not make it an explicit requirement in market standards, but rather require that regulated firms and persons take a comprehensive view of risk, using ESG analysis/factors if appropriate. In this context, ESG is not a straitjacket and there should be room for interpretation.
It is important that those managing investments ensure that in addition to the health crisis posed by COVID-19, another potential disaster is averted — the permanent destruction of value for the pension funds and the savings of wide swathes of the population. Simply put, investors need to be holding the right securities through the crisis.
At Impax, based on the lessons from financial crises over 20 years or more, we are seeking to invest in companies that score well in five key areas. The first two are being vigorously tested right now. Resilience: although no one appears to have anticipated the COVID-19 shock, those companies with low levels of debt, redundancy in supply chains, diversified customer bases and effective business continuity plans have performed relatively well. As for stakeholder management, yes, staff and customers should come first, but we believe those companies with well developed government relations, connections to community groups and other NGOs and proactive social media policies are at an advantage.
The third and fourth dimensions will be assessed over a longer time frame. Take strategy: few business investments pay off in fewer than five years, so most companies need to articulate a plan that will be successful in the world of the late 2020s. By then, the direct and indirect effects of environmental damage, social inequality, political dislocations and demographic change, including urbanization, will have stressed many business plans, but also underpinned countless new business opportunities, for example in personalized healthcare, smart materials and fintech. COVID-19 is an early example of the type of shock that may be in store.
And in terms of leadership: COVID-19 is ruthlessly separating the leaders from the managers, giving those who can inspire and nurture their teams the impetus to adapt quickly, while exposing those who look to the spreadsheets first as “not up to the task.”
Finally, governance: those businesses with effective boards that have systematically provided constructive challenges to management, ensured that risk analysis is rooted in real-world scenarios rather than theoretical box ticking, and checked that business continuity arrangements, including succession plans, are effective are likely to be in better shape today than those that are stumbling in these areas.
At a time of global crisis, talk of how to preserve investment value can sound discordant or even insensitive. However, without effective action in this area, we’re at risk of compounding the problems of large numbers of ordinary people by exposing them to long-term financial distress.
- Ian Simm, Founder and Chief Executive, Impax Asset Management
