Market volatility since the outbreak of the global pandemic triggered wildvariations in the value of defined contribution pension plans.
The so-called global indicator of “fear” among investors – the CBOE VIX Index – hit a 12-year high on 16 March 2020 when it reached levels not seen since the Great Financial Crisis of 2008. More recently, however, volatility has been fluctuating at much lower levels and equity indices have recovered much of the lost ground from the first quarter of the year.
But, as investors take stock of their portfolio performances since the Covid-19 outbreak took hold, assets with superior environmental, social and governance (ESG) metrics appear to have out per formed traditional investments over what is admittedly a very short timeframe. There are no shortage of examples. Take London’s blue chip index, the FTSE 100 for instance. In the year to the end of July 2020, investments in a FTSE 100 tracker would have lost 17.6 per cent, according to FTSE Russell. Those who opted for an ESG version of the same index – the FTSE UK 100 ESG Select Index — would have kept hold of more of their money, losing only 14.6 per cent – a difference of three percentage points.
It’s a similar story with the tech stock heavy S&P 500. The S&P 500 is often touted as containing constituents with superior sustainability credentials, but even this index was trumped by an ESG version. In the year to 31 July 2020, the S&P 500 ESG Index would have gained +4.4 per cent compared to just +2.4 per cent for the standard index.
Time to re-think?
With dozens of other examples to illustrate ESG outperformance, will this lead to a long-term shift in how trustees and advisers assess asset suitability?
“Yes,” says Dalriada Trustees professional trustee David Fogarty, “Although the direction of travel was set prior to Covid-19.”
Fogarty says his organisation is expecting that ESG related regulation will continue to build – a trend they are already seeing. “For trustees it is always important to be cognisant of the number of members invested in the DC default fund,” he adds. “Typically, this can be 80 per cent of members, so the default fund can be quite a significant investment in a DC scheme. Encouragingly, we are finding discussions with DC scheme sponsors to be an open door for incorporating climate change and ESG strategies within DC default fund investment reviews.”
Fogarty’s views are shared by several leading experts who advise DC pensions. The general consensus is that the pandemic has reinforced ideas that were forming prior to Covid-19. The difference now is that they have seen quantifiable evidence of outperformance.
“Aon’s buy-rated sustainable and impact equity strategies have broadly seen attractive relative performance over the period of the pandemic,” says Aon head of DC Investment Chris Inman.
“Since the pandemic started, we have found that DC trustees and members are becoming more interested in what fund managers are doing. They are asking questions such as ‘are their approaches adapting to the changing world?’ or ‘are they sustainable for the future?’ We expect that this will continue and increase post-pandemic.”
A wholesale change
Industry experts hope that the recent burst of superior performance of stocks with strong ESG characteristics during the pandemic will strengthen the arguments for companies to invest in improving their sustainability credentials
It had been previously suggested that a downturn could see investee companies flee from long-term ESG commitments if more immediate cashflow issues soak up the money originally designated for these projects.
However, now that investors have seen outperformance during the crisis, advisers say that pressure for longer-term corporate ESG commitments will only build from here on, leaving companies ittle room to backtrack on their promises.
In the same vein, it had also been suggested that investors would switch away from ESG-friendly companies during a crisis to traditional assets, but that hasn’t happened this time around either.
“For too long, sustainable assets have been viewed by many in the sector as a ‘nice to have’ that look good in the corporate brochure, but that ultimately deliver little investment return,” says Finn Houlihan, managing director, ATC Tax and The Arlo Group UK.
“The Covid pandemic has debunked this myth once and for all and we are seeing sustainable and ESG investments outperform the asset classes once deemed to be safe.”
Views are not just changing in respect of the financial return. The Covid-19 outbreak held a mirror up to society. And many did not like what they saw. This is another supporting reason why ESG investing will see continued growth post-pandemic, say experts.
“The ‘social’ in ESG is perhaps the hardest risk for investors to appreciate, but this issue has been brought to the fore by the pandemic,” explains Buck chief investment officer, UK investment consulting, Carl Hitchman.
“It was recently alleged that fast fashion retailers, which rely upon cramped working conditions, contributed to a spike in Covid-19 in the Leicester area. Following the news, investors showed they were willing to punish these companies for failings in this area, destroying significant shareholder value.”
Hitchman explains that, by highlighting these issues, the pandemic has demonstrated the danger to investors of investing in companies that don’t manage their supply chain risk effectively.
Assessing human impact
Investor views have not only been swayed on the societal element of ESG during the pandemic, however. The environmental impact of corporate behaviours was clearly shown during the various country-wide lockdowns around the world.
River and Mercantile head of defined contribution solutions Niall Alexander says the Covid outbreak effectively allowed people the space to re-evaluate the impact that their decisions have.
Alexander explains that news updates showing how skies had cleared in Delhi, India, for example, really captured investors’ imaginations.
“The pictures were shared around the world, highlighting the positive impact of reducing pollution,” he says.
Redington head of DC & financial wellbeing Jonathan Parker also recognises that investors are taking a closer look at the impact that humans are having on the planet as a result of the pandemic. “This trend had begun to build before Covid-19, with mass participation, social movements like Extinction Rebellion, Fridays for Future and the awareness around plastic pollution,” he recalls. “The knock-on effect of these social movements to investments is more nascent, but organisations such as Share Action and Make My Money Matter are really beginning to make a difference, and this will start to impact investment choices.”
Advisers to DC pension schemes should expect to be fielding increasingly more informed questions from asset owners as a result of the events of 2020. There is also likely to be greater pressure on fund managers to show their work when it comes to the strategies that they offer.
“We believe expectations have changed,” says Newton Investment Management chief commercial officer Julian Lyne.
“Our firm belief is that there is increasingly an expectation that asset managers need not only think about the changing investment landscape, but also to think about their role in society. They will be challenged on their purpose and their contribution to this new world.”
Corporate advisers keen to enhance their ESG knowledge base can now take a series of dedicated professional courses. Last year the CFA launched its Certificate in ESG Investing, while the PRI Academy now offers several courses at different attainment levels.