Is responsible investing more than a ‘coronatrend’?

When planning this piece, I spent far too much time thinking about how I could talk about the pandemic affecting investment markets without using the overused phrases ‘unprecedented’, ‘extreme’ and ‘uncertain’, and also referring to a ‘new normal’.

Alas, I decided it was far too difficult, so to actually do the opposite and cram in as many as possible. While I was at it, I’d add in references to the ‘coronamountain’ of neologisms. It’s unprecedented just how many new words and ‘coronaphrases’ have been added to the English language.

Without downplaying how difficult recent months have been for many, it has been a fascinating period for markets and investors. In particular, many have commented on the surge in interest for responsible investments. This was market turbulence that no-one saw coming; it reminded investors that markets don’t always follow the traditional market cycle and that other idiosyncratic factors can affect fund performance. And we’ve recently seen new equity market highs, despite the significant contractions of global economies – or ‘coronacessions’, which seems to be the new term to describe forced economic shutdowns – which may or may not be short-term. It’s been quite the ‘coronacoaster’ of rides for investors; yet a perfect storm for responsible investing and is now asking the question not “should I, shouldn’t I?”, but “how far does one go?”.

Changing behaviour

The ‘Great Pause’ seems to be changing investor thinking to look beyond the more traditional investment ideas and to consider approaches that counter climate change and improve diversity; to seek greater transparency driven by the increasing focus on that now almost imperious phrase, environmental, social and governance (ESG). At LCP, we’re seeing interest increasing significantly, with investors looking at all types of ESG integration. From the lower cost, passively implemented ESG or low carbon index-tracking opportunities to the high-conviction impact funds. However, interest has also significantly increased in the look-through of existing mandates, with calls on existing managers to report against new metrics. Could investors have found a comfortable middle ground between having absolutely no interest and ethical investing – a term typically associated with giving up financial return for the greater good?

The approach to better informed decisions on sustainable or ESG grounds is resonating much more positively than ever before. Europe experienced a surge of inflows in sustainable funds, raising just over EUR97bn in the first seven months of this year, against outflows for non-sustainable designated funds of EUR27.9bn for the same period. BlackRock’s branding around iShares proposes that “sustainable investing is the future”, while JP Morgan refers to a “a forward-looking approach for a changing world” and “aligning investments with values”. State Street uses the tagline, “ESG was a Nice-to-Have. Is it Now a Must-Have?”. UBS even announced that it will be recommending clients embrace 100% sustainable portfolios as they offer stronger returns than traditional ones.

Different sectors, different impacts?

The timely weighting of ESG strategies away from sectors such as airlines and oil companies and towards technology and healthcare has offered a welcome boost to returns, offering a possibly unintended quality bias; typically, a good factor to have exposure to in troubled markets. Could one argue that ESG-directed portfolio allocations are now a ‘corona-fide’ investment idea simply due to more favourable sector exposures or stock ideas and leaving aside the actual E, S or G benefits? Will these exposures continue to be beneficial to performance if and when life returns to normal, or at least, a ‘new normal’?

If we look at one sector in more detail, there is clear pressure on traditional energy firms, exacerbated by the current turmoil which has favoured strategies underweighting the sector. Let’s take Britain as an example, a country – as George Orwell put it – “founded on coal”. Not only did the country go without any coal use in its electricity production for over 2 months (67 days, 22 hours and 55 minutes to be precise) earlier this year, this only ended due to maintenance testing. Renewables accounted for nearly half of electricity generation in Q1 2020, apparently helped by an unusually windy start to the year. Does the energy example offer evidence that the general trend is likely to continue favouring the tilts and greener allocations while economies take time to switch back on? Even then, does ESG investing offer a better strategy for when that ‘new normal’ arrives?

A new generation of ESG-directed products is helping to lead the charge into investor portfolios. Baillie Gifford’s Positive Change Fund is probably a standout performer, up 55.2% in the first eight months of 2020, compared to just 4.0% for the standard MSCI AC World Index. In the passive space, the World ESG Focus Low Carbon Screened Index and World Low Carbon Target Index provided by MSCI both continue to beat the parent index even if slightly outside of their tracking error target. Importantly, relative performance was positive for these indices in the first half of 2020.

It seems that there is plenty to consider when looking at responsible investing. However, current trend data, performance data, regulatory pressure, economic downturn and structural change brought on by pandemic pressure simply point to the reality that responsible investing is here to stay and is far more than a ‘coronatrend’. We also have social movements such as Make My Money Matter, which could add further focus on sustainable investing. So, the question now is not ‘should you’, it’s ‘how far do you go’? Check with your managers and ask what they are doing to adapt to the more sustainable focus and consider whether they are doing enough to capture the sustainable trend.

Further reading:

Climate tilted equity funds - helping you protect against climate risk, Anais Caldwell-Jones, September 2020

New campaign encourages members to question their pension investments. Are you ready to answer?, Claire Jones, July 2020