Sustainable investing leaps forward in COVID crisis

Sustainable investing has surged during the COVID-19 pandemic¹. Despite recession fears, predictions of mass unemployment and the charity sector facing a huge shortfall in funding, inflows into sustainable funds rose by 72% in 2020’s second quarter, hitting US$71.1bn².

In fact, more new money was poured into environmental, social and corporate governance (ESG) equity funds between April and July 2020 than the total of the previous five years¹.

This trend was steadily growing, albeit much slower, before the pandemic hit. The International Finance Corporation, the World Bank’s private sector branch, estimates that global investor appetite for sustainable investing is as high as US$26trn³.

Investors’ growing penchant for socially and environmentally responsible investments may be partly thanks to generational wealth shifts. At least US$30trn will be passed down from the Baby Boomer generation to Generation X and Millennials over the next three decades in North America alone, Accenture estimates⁴.

Younger investors are increasingly making investment decisions that consider the impact on society. Millennial investors are also twice as likely as others to invest in companies that incorporate Environmental, Social and Governance (ESG) practices⁵. The shifting priorities of investors has not gone unnoticed.

Only 20% of S&P 500 companies gave sustainability reporting to the market in 2011. This figure jumped to 86% by 2018, showing how sustainability concerns went from being the exception to the norm in just a few years⁶.

Consumer preferences are moving towards sustainability too.

Worldwide, people are making an effort to live more sustainably. Across North America, Europe and Asia, 83% of respondents said it was important or extremely important for companies to design products to be reused or recycled, a 2019 survey found⁷.

Sustainable with strong returns

Sustainable investing is no longer a luxury or just for good press. These companies are now often shrewd investments. There are two key reasons for this:

Firstly, environmentally conscious businesses that are maintaining strong values and uphold good governance are more likely to create long-term value than their less socially responsible counter-parts. It’s these businesses with good working cultures, that go to great lengths to ensure employee satisfaction and reduce their environmental footprint, who tend to attract talented staff. This means that as a business, they can create greater knowledge-based intellectual property.

Secondly, reputational risk is a growing concern in our modern 24/7 news cycle.  For good reason, businesses are increasingly worried about how regulators, competitors, customers and even potential employees view them. Companies that are rigorous about good corporate governance lower the chance of having bad press. This helps companies to be valued more highly while they access a lower cost of capital. Sanctions or negative headlines can have such a big knock on company valuations that those that proactively address reputational and regulatory risks are far more likely to see long-term growth than those that don’t.

Identifying tomorrow’s frontrunners

There’s plenty of research to support the financial argument for sustainable investing. MSCI found that higher-scoring ESG companies are more profitable, have lower tail risks, lower market sensitivity and higher valuations⁸, for example.

These characteristics are exactly what tends to allow businesses to survive negative events, such as the COVID-19 market turbulence⁹. Companies that have pushed for positive social and environmental impact have attracted inflows throughout the pandemic, while even conventional funds have lost billions.

Nine of the largest US ESG mutual funds outpaced the S&P 500 Index last year. What’s more, seven performed better than their market benchmarks over the past five years⁷. In fact, at an aggregate level, sustainable equity funds have outstripped traditional funds on a relative basis¹⁰, early Morningstar analysis has found, despite global markets going into bear-market territory for the first time in more than a decade.

This shouldn’t be a surprise - ESG funds tend to be more resilient during downturns, a 2019 white paper found¹¹.

These ESG credentials aren’t just important to consider when assessing critical investment risks, they’re also useful when trying to measure the long-term health and sustainable value of a business, that short-term stock price movements don’t show. Between COVID-19 and climate change, it’s hard to imagine sustainable investing being a passing trend.

Harnessing financial markets for good

In the midst of the COVID-19 pandemic, it’s easy to forget the horrors of the Australian bushfires in early 2020. This event clearly demonstrated how the speed and severity of climate change is already creating shattering social and economic consequences. When the World Economic Forum surveyed 800 economic experts on the biggest threats to human prosperity over the next ten years, climate change came out on top¹⁰. It’s vital that we channel capital into what some would argue is the most effective medium we have to harness human ingenuity: the market.

A dynamic market economy, spurring constant innovation, is one of our most powerful agents for change. Financial markets naturally sort through solutions, rooting out and supporting the most radical innovations that have the best chance of material success.

On the frontlines for our future

Machine learning is already creating huge advances in sustainability, in areas such as agriculture, for example. These advances hinge on increasingly shrinking silicon nodes - data structures used in computer science.  Making them smaller lowers costs and materials used, while boosting performance. There’s only one supplier of the essential technology needed for continued node shrinkage: ASML. This technology is called Extreme Ultra Violet photolithography systems. Therefore, ASML is on the frontline of this technological advance.

The adoption of advanced technology, including cloud computing and the Internet of Things, is now possible thanks to improved processing power, 5G and lower costs for computing memory. These tools give us the chance to take huge steps forward in global sustainability, whether that is by tracking air quality to identify pollution sources or using smart grid solutions to allow greater efficiency in renewable energy solutions. Machine learning is already being used for quicker drug discovery, for example. Combining predictive analytics allows us to calculate the chance of natural disasters and better monitor disease outbreaks.

Drug development has been transformed using AI and the ability to quickly share data worldwide, allowing the production of essential drugs to be dramatically accelerated. Faced with the urgent need for a COVID-19 vaccine, companies such as Johnson & Johnson are using both of these to act quickly¹².

With sustainability issues creating challenges across industries and countries, we need to be able to use this kind of problem solving to address them. Technology such as AI can create benefits across the board, whether it’s solving environmental damage, water scarcity, growing healthcare costs, antimicrobial resistance, food security or the transition to a low-carbon economy.

This isn’t just a pipedream: a recent report shows that global final energy consumption in 2050 could be reduced to the levels of the 1960s, despite a population three times larger¹³. However, in such a world, advanced technologies will need to be employed en masse across all sectors, as well as changing what we consume and the amount of it.

Of course, identifying companies as having strong ESG credentials isn’t always clear cut. Some that appear to be environmentally friendly can face reputational difficulties too. For example, plans for what would be the world’s largest solar farm - Cleve Hill solar park - have been campaigned against by environmentalists for several years, including Greenpeace and the Campaign to Protect Rural England¹⁴.

While it could bring clean energy to 91,000 UK homes, it would also be the world’s largest store of lithium-ion batteries. These are known to be extremely flammable¹⁵. As its planned to be built next to a residential area in Kent, England, concerns have been raised that the solar park could be a threat to the lives of those living in the county¹⁶.

However, the developers say the project will bring over £1m in revenue to local councils each year of its lifespan, as well as cheap, green energy to the UK¹⁷. The multifaceted nature of ESG considerations is just one of the reasons why we actively manage our investments at Barclays International Bank, analysing individual stocks over the long-term. By proactively engaging as investors, it gives us the opportunity to discuss strategy and ESG risks that could impact future cash generation with the management of companies we invest in.

Harnessing the power of the market

As sustainable investing is a relatively new segment, there is yet to be clearly defined measurements of success in all areas. However, in order to end poverty, protect the planet and ensure peace and prosperity for all by 2030¹⁸, the United Nations has set out 17 clear goals. These goals identify our universal rights and the critical areas needed to ensure everybody has them.

Any of these 17 goals present vast economic opportunities to any knowledge-based companies that can address them. To achieve all 17, the UN Global Compact estimates that US$2trn will need to be invested every year.

The market has woken up to the huge economic potential of sustainable investing. We now have an immense opportunity to use the power of business for profit to create a better world. Philanthropy and public spending are not able to match the capital markets’ size and scope, holding more than US$200trn. This means that capital markets are the best chance we have in achieving all of the UN’s Sustainable Development Goals (SDGs).

How we allocate capital is hugely important as investors. It’s in our power to propel forward companies of exceptional financial quality, led by high-calibre, long-term and forward-thinking management teams with significant capacity for innovation and radical thinking.

The world can change for the better, if investors maintain high ESG standards with clear policies on all material ESG issues, including environmental management, human rights and renewable energy. Investing in sustainable businesses that are pushing the bar and developing innovative solutions that directly support the SDGs may be the best chance we have.

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