Ethical investing will reign after Covid-19. Here’s how companies can prepare
As Asia and the Pacific emerges from the pandemic, companies must embrace principle as well as profit.
It’s variously known as responsible, ethical, or impact investing. Whatever the name, investing in pursuit of both financial return and socially desirable outcomes, or at least to avoid undesirable ones, has gained remarkable traction over the past decade or so. In the era of Covid-19 and its aftermath, it is set to become even more popular.
|Ethical investments, including those that take environmental protection into account, will be critical as countries emerge from the pandemic. Photo: Pathum Danthanarayana|
Environment, Social and Governance (ESG) investing, to use its most technical moniker, is gaining growing attention from governments and businesses partly due to increasing global recognition of the need to protect the environment—particularly by mitigating and adapting to climate change—through social responsible and accountable business activities.
The rise of ESG also reflects intensifying controversies around modern capitalism, which has been criticized for sacrificing stakeholder—consumers, employees, communities—interest over those of shareholders. Global institutions such as MSCI and Thompson Reuters are publishing indexes to help such investments. Large corporations are publishing reports on ESG not only as a business record but to win good PR. Globally renowned consulting firms are establishing or expanding their ESG channels to entertain increasing market demands for firm-level diagnosis and prescriptions.
Covid-19 has exposed many public and private corporations to unprecedented risks due to crashing demand, an inability of employees to come to work due to lockdowns or illness, and disruption of supply chains. This has triggered a global stock market plunge, although the financial market fallout was contained in March with the help of central banks’ swift and massive interventions into treasury, mortgage, municipal and even the high-yield corporate bond market.
ESG funds have weathered the storm better than traditional investments. According to Bloomberg, the average ESG fund has fallen by around 12% in the year-to-date, about half the decrease in the S&P 500. The oil price plunge due to uncertain consumption and demand recovery prospects has contributed to this outperformance, as by nature ESG funds have limited exposure to fossil-fuel industries such as oil and gas, as well as energy-intensive industries like airlines and maritime transport.
Furthermore, these funds invest more in renewable energy, telecommuting, distance learning and telehealth. They also focus on companies with high transparency and a socially conscious approach to their workers and communities, thereby connecting with the need for better social protection to shield people and society from the worst depredations of the pandemic.
Many firms are coping with the pandemic-induced crisis through efforts to minimize job losses and pay their suppliers—mainly small and medium-sized enterprises— out of their own working capital. Not all companies are so far-sighted. Some sit on free cash flows but don’t deploy them to support their workforce and suppliers.
The post-Covid world is a place better suited for the former type of company. Investors will become even more conscious about the importance of public goods like sustainability and disaster risk management, and the value of stakeholder protection. ESG funds can play a key role in the recovery from Covid-19 by making large-scale stimulus packages more inclusive and more focused on the environment. ESG investing to prompt positive social change, pursue sustainable and green growth, and enhance resilience against disasters, both health-related and natural, will receive renewed attention in the global financial market.
Businesses will come under mounting pressure to adjust to this reality, and those which proactively embrace environmentally and socially responsible business models will be rewarded with rising profits as well as the loyalty of a socially committed investor and customer base. Developing countries are not immune to this trend. Commitment to Sustainable Development Goals and climate change action through initiatives such as the Paris Accord will become even more important policy priorities for governments, given the pandemic has exposed and further worsened levels of inequality, vulnerability and marginalization.
This trend will be deeply entrenched in the financial markets. Companies need to be prepared to incorporate ESG metrics into their business and operational goals as well as their risk management toolboxes. Foreign investors might start turning their backs on companies which lag on social and environmental consciousness. Reinforcing this trend is the reality that investors will become more wary of reputational risks if firms they’ve invested in don’t live up to desirable environmental and social norms.
To avoid these scenarios, companies can take three initial steps. First, they need to recalibrate their business goals to encompass mid-to-long term environmental and social achievements beyond short-term earnings and profit targets. Second, they should adopt an appropriate evaluation and reward mechanism to enhance corporate governance that safeguards workforce welfare, customer and supplier relationships, and engagement with the community.
Finally, companies can strengthen accountability towards various stakeholders by employing accurate and transparent accounting and outreach programs so they can also effectively monitor their needs and priorities. International institutions, including multilateral development banks, will also face growing expectations to proactively adopt ESG principles.
Covid-19 has exposed humankind to so many challenges. A key lesson is the importance of sustainability, resilience and social responsibility of businesses and investments. After the pandemic, a duty of care for the natural environment, communities, and their employees, will be key metrics of business success.
Companies must embrace principle as well as profit, and they need to start doing that now.
Jong Woo Kang is Principal Economist, Economic Research and Regional Cooperation Department, ADB.
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