The Environmental, Social and Corporate Governance emperor has clothes The Environmental, Social and Corporate Governance emperor has clothes\images\insights\article\closet-dresses-forest-small.jpg August 24 2020 May 27 2020

The ESG emperor has clothes

In times of crisis, human capital and stewardship matter even more.

Published May 27 2020

As the world wrestles with the impacts from the coronavirus, there is a strong sense that our interactions have changed irrevocably and a conviction that the public and private sectors will need to do things differently in the future. Covid-19 created an exogenous shock that brought disruption to the global economy and exposed a lack of preparedness in an increasingly globalized and interconnected planet. The scale of the pandemic and the subsequent response have put the spotlight on the middle “S” of environmental, social & governance (ESG) factors. Once pigeonholed as soft and intangible, social issues are proving to be every bit as important as other ESG topics.

Adapting with purpose

Mounting financial and social stress are making it clear that some companies are better positioned to weather the turmoil. For example:

  • Organizations with strong balance sheets and solid contingency plans, including investments in necessary technology, have been more capable of keeping people in their jobs and productive throughout this unsettled period.
  • Companies with policies already in place for flexible/remote work arrangements have been better able to support those who need to care for children or elderly relatives.
  • Grocery stores and hospitals that emphasize health and safety have been able to accelerate distribution of protective equipment to frontline employees who are essential to our own wellbeing.
  • Firms with practices based on integrity and prudent planning have been more likely to fulfil their contracts with suppliers.
  • Corporations that place doing what’s right alongside profitability have fared better, such as manufacturers that have retooled production lines to produce ventilators or face masks.

Doing good is doing well

Amid a global recession, companies considered to have the best social pillar scores have weathered the market downturn relatively well thus far. According to our proprietary ESG data as well as third-party scores, year-to-date, S&P 500 constituents in the top-quintile of social sustainability have outperformed the bottom-quintile social laggards.    

During a crisis, good things get magnified, just as bad things do. It’s when companies with a clear purpose and a philosophy of long-term, visionary thinking—rather than a short-term, next-quarter-earnings perspective—typically prove to be more resilient to exogenous shocks. Long-term investors such as Federated Hermes that have in place a robust engagement process can provide companies with the opportunity for patient capital during these times.

Financial fundamentals in combination with ESG criteria are proving to be reliable indicators of whether a firm is well-run and has a sustainable business model capable of adding stakeholder value through the cycle. For many investment managers, navigating this new reality will require them to re-evaluate their investing approach. By contrast, it will be business as usual for those who have been defining and utilizing ESG integration best practices.

Stewardship a key to sustainable wealth creation

Widespread impacts from Covid-19, and the winners and losers it likely will leave in its wake, are shining a light on the value of robust stewardship practices. To effectively engage with a company for a positive impact, it’s becoming increasingly apparent that investors must understand its business model, governance requirements, customers, suppliers and specific operational needs. Such intentional engagement almost certainly will be essential to helping prepare for future black swan events.

People invest capital to compound wealth over the long term. There is no point making an investment that strongly grows in value one year, only to collapse at some point shortly thereafter. That’s the risk investors run when businesses suffer reputational, governance or operational failures that structurally harm their business models. Evaluating material ESG issues is becoming inseparable from conducting traditional fundamental research. Previously, cynics warned that responsible investment strategies would underperform in a downturn. Instead, the ESG emperor has been shown to be fully clothed.

Tags Coronavirus . Responsible Investing . Active Management .

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designated to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.

There is no guarantee that considering ESG risks will be a successful investment approach.

Federated Advisory Services Company

Hermes Investment Management Limited.