Over the last decade, ESG awareness saw a relatively steady progress. The conversations culminated in 2019 when young environmental activist, Greta Thunberg led the largest climate strike in history. Months later, then world was met with an unprecedented pandemic which furthered ESG issues to the forefront.
The COVID-19 pandemic has highlighted a number of ESG issues from climate change to unequal access to healthcare and the focus on these issues are here to stay. There has been a growing recognition of climate change as a global priority. Various governments and organizations have made pledges to transition to NetZero emissions as soon as the year 2030.
As society’s expectations and scrutiny of corporate practices and behaviours increase, with it investor preferences will continue to change. In the aftermath of the COVID-19 crisis, investors will increasingly consider ESG factors in an attempt to plug the gaps created by the pandemic. Advances in approaches to sustainable investing and capital allocation in supporting this endeavour will be critical to the outcome. Global investment companies such as Fidelity have already seen a marked increase in conversations about ESG with their clients not only in Europe but also in Asia, including China.
2020 saw record inflows into ESG funds, and this trend will only keep growing. Morningstar has estimated approximately US$373 billion flowed out of mutual funds in the first quarter of last year but, within those figures, there was a US$38.8billion rise in assets held in ESG funds. The trend accelerated as the year progressed and by the end of 2020 total assets held in sustainable funds hit US$1.7trillion, a 50% rise from where they started at the beginning of the year. There are now over 500 sustainability-focused index funds amounting to more than US$250 billion in US assets, and a Celent report estimates that the industry will grow to US$53 trillion by next year.
Rise of the social element
An area that is hot on the lips of investors is the social aspect of ESG. Amongst many other things that came to light over the course of 2020, one that was most prominent was the call for more equality, racial and gender justice, and in general, more respect for one another, particularly following the murder of George Floyd. Investors will continue to press companies on social issues, particularly around COVID-19, worker safety, and diversity.
The COVID-19 crisis will have a profound and sustained impact on corporate social responsibility practices. As the pandemic continues to reveal the weak points of our societies and highlight the need for social responsibility towards local communities, the social element in ESG will move to the forefront of every agenda. Investors will only consider companies who manage to maintain a humane approach and put their employees first as sustainable long-term investments. Naturally, there will be an impact on equities and corporate bonds.
Value in companies are now increasingly defined by how they evolve and progress. Long term shareholder value is created and increased when a company takes care of their stakeholders such as employees, clients and suppliers. ESG has been an increasing priority not only for individual investors but also for large institutional investors. The pandemic seems to have accelerated the move to ESG with greater importance being placed on companies being able to survive negative shocks and prove sustainable in the long term.
A recent study by Fidelity on company performance during the volatile period of February and March last year found that companies with high sustainability ratings performed better than their peers as markets fell. This supported the theory that companies with good sustainability characteristics have more prudent management and will demonstrate greater resilience in a crisis.
The groups that had the groups with higher ESG ratings fell less as the markets collapsed and rose less when they recovered sharply in April than those with lower ESG ratings. This suggests that those stocks with higher ESG ratings are less prone to volatility in the broader market. Analysis like this can suggest broad trends in markets but investors also need to remember the circumstantial factors that were at play—such as the downward rerating for oil stocks last year, which most ESG funds won’t hold.
The questions Fidelity poses now is on the performance of ESG if economic performance improves as nations begin to roll out vaccinations and emerge from lockdown. ESG funds have done well from the continued outperformance of high-quality companies—those whose shares are highly valued compared to their earnings, but whose earnings continue to grow steadily. If there is a sustained rotation towards less highly valued companies then the performance of ESG fund could be put under pressure.
2021 – The Year of Green Bonds
Since former US President Donald Trump made an announcement to leave the Paris agreement in 2017, the climate change agenda has been a common headline in the press. A bid to counter the effects of the Trump administration’s backpedalling on environmental policies, global organizations have strived to maintain their ESG policies rolling out various green initiatives including the issuing green bonds. Investors will continue to drive a growing demand for resilient and renewable energy sources, next to greener and more sustainable transport networks and buildings.
As the sustainability bond market continues to grow, the global green bond supply is predicted to jump 50% in 2021 and it still may not be enough to satisfy investor demand. After a record year for sustainability-related debt issuance, demand for sustainable and green bonds is set to go through the roof this year. According to S&P Global Ratings, global sustainable debt issuance is expected to surpass $700 billion in 2021, up from $500 million from 2020.
The Role of Tech and Data
Companies have long struggled to report on their social impact in a financially meaningful manner and have taken solace in reporting efforts as opposed to impact. With the social element of ESG becoming more important in investment decisions, many expect to see the emergence of new concepts and technologies as well as a renewed focus on ESG integration driven by data. At Tradesocio, our advanced digital wealth advisory solutions are built with powerful algorithms as well as an open and scalable architecture to support our client’s ESG requirements.
In 2021 and beyond, investors will explore opportunities to invest in equitable and resilient communities. This will be done through a diversified asset allocation targeting risk-adjusted market-rate returns. Transparency and ESG integration will become more profound and data will play a key role to support investors in making the right decisions.