Covid-19 is a sustainable investing paradox. It has rightly diverted the immediate attention of corporate boardrooms and policymakers to crisis management, slowing governments’ ability to focus on environmental, social and governance (ESG) agendas. At the same time, it has tragically underscored how connected human beings and societies are to nature. If one part of the ecosystem falls ill, the immunity of the whole system is compromised.
The virus is in part a symptom of our collective, chronic mistreatment of nature, in the sense that environmental degradation played at least a partial role in exacerbating our public health vulnerabilities. Equally urgent and salient, the importance of social and governance factors in company and government management have been made all too clear.
This pandemic will transform the tenets of sustainable investing (ESG factors), accelerating some aspects and reshaping others.
There are material implications for the E, S and G on the horizon.
First, the environment. The first thought is often of lockdown-induced drops in pollution, although these are fleeting by definition. European Space Agency or NASA satellite images show substantial drops of nitrogen dioxide concentrations in many countries, down a dramatic 50% in Paris, Rome, Milan and Madrid. But these short-term environment benefits mask a worrying loss of momentum in the fight against climate change.
Indeed, Covid-19 has led to the cancellation of many climate demonstrations and more importantly to the postponement of the COP 26 Climate Conference to 2021. This is an important setback as more than ever the clock is ticking for the climate.
A rapid increase in fossil fuel consumption as economies start to reopen and recover over the mid- to long term is a concern, but there are reasons to be optimistic about this. The cost of producing and storing electricity from renewable power such as wind and solar is becoming increasingly competitive which will soften the reality of economic-recovery-linked, greenhouse gas emission rises.
Given the significant volatility in oil price changes just in the last few weeks, increasing pressure on oil dependant nations to diversify their revenue sources also bodes well for a greener future, the International Energy Agency predicts revenues to drop by as much as 80% for the largest producers.
On the policy front, postponement of climate risk mitigation policies should prove temporary as governments and companies will need to step up their climate adaptation measures to be better prepared for the next crisis.
Second, when it comes to the critical social dimension, more than any other crisis before, Covid-19 magnifies inequality. Between families and workforces who have access to adequate healthcare, education and technology – and those who do not.
The US Bureau of Labour Statistics shows that 61.5% of the workers with earnings greater than the 75th percentile have the ability to work from home, only 9.2% of those earning less than the 25th percentile have the ability to do so.
Covid-19 not only increases inequality within societies but also between countries, as poor emerging countries are hurt the most – luckily so far not so much by the pandemic itself but more by the economic consequences of the lockdown measures taken globally.
It is on the economic front that the situation is worst, as many poor countries rely on financial flows/remittances from their diaspora in rich countries. For a country like Senegal, these remittances account for 10% of GDP and 62% of these flows come from countries which have implemented lockdowns which means that these flows are drying up.
Most countries have implemented measures to cushion the impact of the crisis on their population, but generous unemployment benefits and other similar mechanisms only apply to those who have an official work contract. This is not as helpful in emerging countries with informal economies.
In the long run, the social consequences of Covid-19 will shift supply and demand dynamics meaningfully.
There may be greater job displacement due to increased automation. Many estimates already suggest around one third of the global workforce will have their jobs disrupted by artificial intelligence and automation over the next decade, peaking at moments of economic downturn. Whilst automation replaces many workers stuck at home as a result of Covid-19 restrictions, their jobs could be lost to technology forever.
As a consequence, governments will face the risk of heightened populism arising from the huge disparities among workers. Corporations will need to step up their investments in their human capital through continuous trainings, improving the health and safety conditions of workers. These measures will inevitably increase unit labour costs but should help a more skilled workforce ensure growth sustainability over time.
Similarly, we can expect to see more tech-enhanced healthcare delivery and systems worldwide. Providers now are racing to adopt virtualised treatment approaches that eliminate the need for physical meetings. Already Microsoft have launched a healthcare bot service to deliver medical care on the frontlines of the Covid-19 response to help with screening.
Changes to supply chains are also coming. Goods and services are having to be sourced locally in many economies due to lockdowns. While this could be good news from the perspective of carbon emission reduction, it could also mean bad news for emerging markets facing prolonged unemployment as demand for their previously exported goods dries up and the workforce cannot upskill quickly as economies transition to a more equal service and manufacturing mix.
Finally, when it comes to the dimension of governance, the virus has been a giant stress-test of global corporate resilience. The sudden evaporation of income in many sectors, together with the need to completely and rapidly reorganise value chains and customer interaction, has proven deeply disruptive for many businesses.
Unsurprisingly, companies with the best governance are on firmer footing. Defensive capital allocation strategies have been rewarded as ample balance sheet cash has suddenly become more prized than current dividend yields, which now look vulnerable. Indeed, markets are pricing dividend cuts of respectively 22% in the US, 30% in Japan, 45% in Europe and 51% in the UK.
In this context, companies with a higher governance score have outperformed their peers globally this year by a wide margin. Indeed, according to MSCI data, the MSCI World Governance Quality index is down 7.5% year-to-date (YTD) while MSCI World is down 16% YTD.
For the long term, boards will have to ensure the company’s own sustainability and financial resilience is strong. The recession will force companies to confront challenging capital allocation questions where compromise will be required. Beleaguered companies are right to hold higher cash reserves in this unprecedented crisis, but trickier moral questions about the role of capital allocation in a healthy capital market system lie ahead in the longer term.
Covid-19 calls on us not to abandon the tenants of sustainable investing, but to speed them up. The ESG agenda is more importantly globally than it has ever been, as something that strengthens the resilience of our societies and companies.
While policymaker initiatives may be understandably diverted in the short term, there is no time to waste for investors. Indeed, private investors can fill in the gap with a long-term perspective as governments are in crisis management mode. Early indication from investment flows, which reflect stronger inflows to sustainable investment funds in Q1 2020 than in the entirety of 2019, suggest this is happening already. For all stakeholders’ sakes, it is time for investors to step up.
Jennifer Wu is global head of sustainable investing at J.P. Morgan Asset Management.
