On Our Watch: ESG in the Time of COVID-19

Here’s something you don’t see much of these days, a market doing well and with the potential for real “green” shoots. With an emphasis on social responsibility and community support, ESG investing is a bright spot. Still, there are also reasons to be cautious, especially if social issues dominate over environmental ones. There are good reasons to keep investing in both.

Positive Market Results

ESG funds are outperforming conventional funds, and have been since late March. The ESG market has been weathering the storm better than other markets, with the average ESG fund only falling around 12% since the onset of the crisis. It’s not a surprise, as there were predictions ESG would prove to be more resilient than other investment options. For example, BlackRock claimed in 2019 that ESG funds would fare better than others in, what was at that time, just a potential market recession or depression.

As humans’ need for mobility ground to a halt amid stay-at-home orders and the oil market crashed, the coronavirus pandemic exposed the economy’s dependence on energy prices. When Saudi Arabia devalued its oil in late March, stocks of companies heavily reliant on traditional forms of energy tanked. Investors turned to the renewable energy sector for relief.

MarketWatch’s list of 200 S&P 500 companies that are leading the economy in managing climate risk have been collectively outperforming the rest of the market by 33% since the pandemic began. They were able to avoid the worst of the turmoil thus far in part because they avoided the oil market altogether.

Social Responsibility and Employee Support

A number of banks have begun to prepare for the influx of “social” inquiries from ESG investors. For example, Barclays is providing ESG assessments for all of its related entities and Citigroup sent a notice to clients informing them that investors have been asking increasing questions focused on employment benefits and loan relief the bank has provided since the outbreak.

Since mid-March, ESG investors have turned to companies that have taken the steps to manage a number of non-financial risks – specifically, the companies that have planned for a variety of disasters and have emphasized the significance of employee treatment and well-being.

Investors are now more aware than ever that the more satisfied employees are, the higher their engagement and productivity. Companies that are ensuring their employees have less on their plate to worry about are predicted to do well in the coming months. Bonuses given to support purchases that enable easier remote accessibility or that can be used toward urgent costs give employees one less thing to stress about as they transition to working from home. Some employers are going as far as to still compensate employees even though stores are cutting shifts or temporarily closing.

Furloughs might provide some companies with much needed financial relief in the immediate face of this crisis. However, ESG investors may be worried temporary workforce reductions cause more harm than good in the long run, given the investment in retraining that may need to occur when the economy begins to reopen. A resulting decrease in productivity could put companies that were forced to lay off or furlough workers at a disadvantage to those who did not.

Investors are not shying away from companies that are struggling, but want to see reductions in the salaries of executives to demonstrate management is taking responsibility and sharing the pain. Conversely, there is strong distrust in issuers undertaking massive stock buybacks, which are being viewed as a way for wealthy executives to maintain their salaries during the pandemic.

Community Relief Efforts or Social Washing

While everyone’s inbox has been flooded with emails from retailers and companies informing their consumers about how they are managing the crisis, companies that are actually shifting normal production to things like personal protective equipment (PPE) or medical devices are likely to be especially appealing to investors and consumers alike, as they are demonstrating community investment and socially-conscious action.

There are concerns that ESG might not continue to do so well as the crisis continues to unfold. Some companies might interpret social policies as an obstacle for them to overcome as they try to recover from the economic turmoil. Additionally, as ESG investing grows, so does awareness of “social washing.” So far, there really is no consistent or clear way to measure just how certain actions and initiatives are impacting things such as labor or human rights. Performance benchmarks are not as consistent and formulaic as they are in the environmental corner of ESG. This makes it challenging to avoid issuers who are exaggerating or misrepresenting how they are benefiting their employees.

Looking Ahead

While a tremendous amount of capital has been put towards health and safety during this pandemic, it leaves open the question of whether companies and investors might not keep up their commitment to environmental concerns. We’ve already seen public concerns about hygiene and the virus drive people back to disposable items over sustainable ones.

But this is not the time to lose focus on the “E” in ESG. A recent Harvard study found a link between death rates and environmental factors: the higher the level of air pollution in a given area, the more likely people were to become victims to the coronavirus. Continuing to invest in carbon emissions reduction will continue to serve health and social goals. Since citizens have been forced to stay at home, images have gone viral of once-polluted cities that are now free of smog and those that now have clearer waterways, which show a temporary fall in air and water pollution and could indicate what could happen if people take action to change their behaviors even post-coronavirus.

The recently-passed CARES Act specifically excluded the wind and solar industries from tax credits and direct pay provisions, suggesting carbon emissions are not the government’s first priority in this moment. Environmental issues and regulations might not be at the top of the list for every company in economic hot water during the pandemic, but, if more data emerges linking pollution to disease susceptibility, the “E” might be just as important as the “S” for investors in the coming months and years.

The ESG sector had its best year on record in 2019, with investments pulling in $20.6 billion, which quadrupled the previous record high of 2018. Although ESG investment is now facing an unprecedented economic challenge, COVID-19 has shown us that we are interconnected in more ways than we may have realized. It’s a reminder that environmental and social issues, too, are intertwined, and investment in both may be the way forward.

Nicole Serratore, an Attorney, in the Insolvency, Creditors’ Rights & Financial Products Practice Group of Davis & Gilbert, contributed to this post and Megan O'Malley, a paralegal in the Insolvency, Creditor’s Rights and Financial Products Group, assisted with this post.

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