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The new normal in sustainable investing post-COVID-19

In John Lennon’s last album, in 1980, he released the song "Beautiful Boy," which showcased his deep love for his son Sean. The song’s lyrics included the prophetic quote "Life is what happens to you while you're busy making other plans."

As we struggle to bring into focus the long-term impacts of a post-COVID-19 world, Lennon’s quote is a poignant reminder of the uncertainties that lie ahead for corporate sustainability executives and investors. 

We are approaching an inflection point in the crisis where savvy investors are fundamentally reassessing economic, environmental, social and governance factors to adjust to the new normal. Many investment firms are modifying their strategies and valuation models over the long-term in the wake of the pandemic.

Anecdotal evidence suggests that ESG-attuned funds were sticky and held their value relative to their benchmarks during the pandemic.
Here’s how astute investors can equip themselves for a volatile future by determining whether the companies they hold are future-fit.

 

Current state of play

According to Morningstar’s Jon Hale, funds that integrate environmental, social and/or governance (ESG) factors registered record growth in Q1 2020 that eclipsed the previous watershed moment in Q4 2019. "Sustainable funds in the United States set a record for flows in the first quarter [of 2020]," wrote Hale. "ETFs, passive funds and iShares dominate as U.S. ESG funds gather $10.5 billion in the first quarter."

What’s more, anecdotal evidence suggests that ESG-attuned funds were sticky and held their value relative to their benchmarks. This early signal bodes well for sustainable investors and could serve as a proof point for how investors can trust ESG funds in turbulent markets.

Many investors are reimagining the future state of investing in the aftermath of the pandemic. Important considerations come into play in preparing for the future such as: What does the U.S. government’s current response to the crisis portend for the economy over the next three years? How do we know if a company is resilient and positioned for growth over the long term? And do we have the information we need to evaluate companies’ long-term performance outlook? 

Emerging megatrends in the U.S.

Over the next 12 to 36 months, the following six megatrends promise to reshape the business practices and investing:

1. Deficits squeeze firms relying on government procurement

In 2021, political and financial market pressure for deficit reduction will mount as markets adjust to the economic realities resulting from the record stimulus. This will adversely affect companies that rely on government funding as budgets are slashed in an effort to stabilize the economy.

2. Inflation roars as a result of stimulus and quantitative easing

As of April, the first wave of COVID-19 stimulus and quantitative easing surpassed $2 trillion, three times the amount of the 2008 financial crisis bailout and more than five times the amount of President Barack Obama’s 2009 stimulus. The likely result of the most extensive bailout in U.S. history is that inflation rates will soar, perhaps eclipsing 10 percent, similar to what the nation experienced in the early 1970s. Companies unable to adapt quickly to inflation will be adversely affected in this new economy.

3. Commercial real estate bubble emerges from business closures

One prominent economist reported that bars in the U.S. had, on average, enough cash cushion to sustain closure for only 22 days. And as of today, over 50 percent of all stores in the U.S. are closed. Government support will help but will not be enough or come fast enough to prevent a commercial real estate bubble. What’s more, the growth of online shopping will continue to accelerate, exacerbating pressure on brick-and-mortar commerce.

4. Unemployment lingers at around 10 percent 

In mid-April, unemployment claims jumped again as COVID-19 virus toll reached 22 million, more than the total number of jobs created over the last 10 years. This translates into an unemployment rate of about 16 percent. This should level off around 10 percent within 12 months, but we are in for a period of sustained high unemployment rates for the foreseeable future.

5. Multiple capitals thinking transforms decision making

The recent $2 trillion stimulus also includes a $500 billion bailout for companies hardest hit by the pandemic. Many progressive thought leaders such as American Prospect’s David Dayen objected to the bailout on the grounds that these corporations wouldn’t need it if they hadn’t "squandered their record-high profits on payouts to CEOs and shareholders."

As a result, a new way of thinking is emerging that is transforming the way we value a company’s relationship with nature, people, society and shareholders. This "Capitals Thinking" approach is championed by the Capitals Coalition and aims to reshape how investors engage on corporate governance and value the relationship between commerce, people and nature.

6. ESG investing becomes the new normal

Within 36 months there will no longer be a discernable distinction between sustainable and traditional investing. As sustainable investing continues to scale and become infused on Main Street and Wall Street, high-quality investment managers will use multiple capitals thinking and integrate financially material ESG considerations in engagement strategies and investment decision-making. This will be the silver lining of the crisis. 

Collectively these megatrends, each with a distinct but linked role in the emerging investment landscape, will:

  • transform the way corporate sustainability information is used by developing new disclosure expectations for material sustainability information and value-generating strategies based on existing standards;
  • reposition corporate reporting to tell a more complete story of how an organization’s strategy, governance, performance and products lead to the creation of value over the short, medium and long term through a multiple capitals prism;
  • improve the precision, materiality and disclosure of sector-based sustainability KPIs and accounting metrics;
  • accelerate the integration of ESG factors into investment and credit rating decision making.

The time has passed for small commitments, hyperbole and delays in embracing sustainable investing. Now is the time for leadership, investment and action. Companies and investment managers that remain on the sidelines will sacrifice their opportunity to shape their own, and the planet’s, future.

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