Investment Strategies
Pandemic: ESG's Death Knell Or New Beginning?

What effect has the global pandemic had on the trend known as ESG investing? Is it a net plus for the idea or has it actually pushed the concept backwards? If the focus in the coming months is on how to raise growth, create jobs and pay down huge debts, can the world afford some of the ideas associated with ESG. This article examines such points.
Is the pandemic the end of environmental, social or
governance-driven investing or a new beginning? It might seem a
bizarre question n view of the fact that the virus has
highlighted concerns over food hygiene, the treatment of animals
and its affect on humans. However, another concern is the
accountability – or lack of it – of governments, NGOs, and some
private firms. The impact on civil liberties from the lockdowns
is also worrying, as is the divisive impact of COVID-19; some
people have continued to work, some were made redundant and
others have had to close their businesses. Even so, when the
pandemic struck, it did appear, as far as this publication could
tell, to put a few established ESG themes in the shade for a few
weeks. And to be frank, that was possibly not a bad thing. To a
certain extent, ESG commentary had become stale and needed
freshening up.
To discuss what the pandemic means for the ESG approach are
Indranil Ghosh and Shelly Goldberg. Goldberg is the founder
and principal of Invest-With-Purpose,
an environmental sustainability investment management and
strategy consultancy. With more than 20 years of experience in
structuring and managing portfolios, she runs an environmental
sustainability consultancy and investment management practice. Dr
Ghosh is an MIT-trained scientist, a sustainable investor,
author, and a strategic advisor to governments and leading global
corporations. Prior to Tiger Hill
Capital, Dr Ghosh was head of strategy at Mubadala, Abu
Dhabi’s Sovereign Investment and Development Fund, working in
senior roles at Bridgewater Associates and McKinsey & Co.
The editors, as ever, don’t necessarily endorse all views of
guest contributors and invite readers to jump into the
conversation. We are grateful for this contribution to debate.
Email tom.burroughes@wealthbriefing.com
and jackie.bennion@clearviewpublishing.com
Five years ago, many people dismissed environmental, social, and
corporate governance investing as a fad because it put purpose
alongside profit. But today, ESG investing seems to have become
mainstream as global flows into sustainable investing are worth
upwards of $4 trillion annually. Furthermore, as the COVID-19
crisis mounted in Q1 2020, investors poured $45.6 billion into
ESG funds while $384.7 billion flowed out of the overall fund
universe.
According to the UN, the funding gap to meet the Sustainable
Development Goals is at least $2.5-3 trillion annually in
developing countries alone. We think it is more like $5 trillion
globally. Plugging this gap from the public purse would require a
20 per cent increase in the global tax base, which stands at
about $25 trillion today. Clearly, this is not feasible. However,
steering a small portion of global private wealth, which stands
at $200 trillion globally, into sustainable investments could
address the world’s development challenges.
Fortunately, investor interest in ESG opportunities has grown
steadily as evidence continues to mount that the pursuit of
societal benefits does not compromise financial returns. In line
with an expanding body of research showing that companies with
robust ESG practices outperform their benchmarks, Blackrock’s
latest study shows that 94 per cent of widely-analysed
sustainable stock indices outperformed their benchmarks in Q1
2020.
As public attention zooms in on ESG issues due to the
COVID-19-induced economic crisis and protests following the
killing of George Floyd, many investors are frustrated by the
lack of additive impact generated by ESG investing to date.
Witness the public backlash against Amazon when it emerged that,
in spite of high ESG scores, many of the company’s US warehouse
workers have died from COVID-19 - a tragedy that its employees
attribute to poor working conditions.
Problems with ESG investing
Several challenges with the current ESG investing framework have
thwarted the impact many investors intended to achieve. First,
investment flows trump ESG fundamentals. Approximately 95 per
cent of sustainable investment flows are allocated to
passive ESG funds that rarely engage with company boards to
influence critical changes like carbon emissions or diversity.
ESG funds also tend to flow into large corporations which have
many alternative sources of capital. But it’s often the multitude
of smaller disruptive businesses at the lower end of the
enterprise pyramid - those with direct, pure-play ESG initiatives
- that could make most meaningful impact.
Second, ESG investors are held back by the lack of standards in
measuring and reporting ESG outcomes. While a company may have
the right indicators to check the rating agency boxes, it may not
achieve the desired outcomes. Combined with the lack of a widely
used industry standard for ESG metrics, the door is wide open for
corporations to “ESG-wash” their corporate social responsibility
metrics. Some heavyweight investors such as Blackrock are
rallying behind high-quality reporting guidelines like the
Sustainability Accounting Standards Board (SASB) and the Task
Force on Climate-related Disclosures (TCFD), but we are a long
way from standardisation across ESG ratings.
Third, the universe of active ESG investors - like Trium Capital
and BNP Paribas’ Energy Transition Fund, who engage with their
investee companies to improve their ESG performance - has been
small, albeit this strategy is gaining traction.
Fourth, ESG investing, particularly with its focus on large-cap
companies, has often been viewed as a means of influencing
gradual, long-term improvement in corporate sustainability
practices. However, as the economy is increasingly buffeted by
climate catastrophes, pandemics, and other shocks, the urgency
for ESG investing to address short-term socioeconomic priorities
is likely to be dialled up.
New beginnings
At a time when the costs on society from loss of life, prolonged
economic hardship, and social unrest are becoming increasingly
palpable, ESG investing must be transformed from a futile
administrative exercise to a means for driving much-needed system
change. After all, a sustainable and resilient system is the best
way to drive up overall market returns.
Before the pandemic, climate change was the single biggest focus
for ESG investors. However, the balance is now tilting towards
the "social" pillar since the pandemic has amplified
pre-existing social problems that were blighting our societies.
However, to amplify direct impact and exert greater control over
their investees, ESG investors should also consider ramping up
active engagement with large-cap holdings, as well as deploying
more capital to sustainable infrastructure, corporate credit, and
smaller disruptive companies through private equity, venture
capital, and crowdfunding.
On the active engagement front, asset manager Trium Capital
targets companies in high emissions industries like oil and gas,
utilities, and mining and works collaboratively to help them
transition to higher growth, lower emission, ESG leaders. Some
leading pension funds are also waking up to this trend by
organising collective action. The New York State Common
Retirement Fund, the third largest US public pension fund, plays
a leading role in Carbon Disclosure Project’s Carbon Action
initiative of 304 investors representing $22 trillion that
lobbies for company action on emission reduction and energy
efficiency.
Sustainable infrastructure offers a good fit for institutional
investors such as pension funds since they provide long-term,
contracted cash flows to help with matching pension liabilities
and offer an alternative to holding hydrocarbon assets which are
at risk of becoming “stranded” should tighter carbon emission
regulations be introduced.The Canadian Pension Plan
Investment Board, for example, has formed a joint venture with
Brazilian energy generator Vortarntim Energia to fund the
development of Brazilian wind farms.
Corporate credit may be more effective than equity in driving ESG
specific outcomes and can be tied to loan covenants and
conditions. By contrast, it is more difficult to implement such
conditionality and even attempts at active engagement can be
diluted by new share issuance or share buybacks.
Smaller companies face a measurably constrained funding
environment, which has only been exacerbated by the crisis.
Funding for US start-ups fell by 16 per cent in Q1 2020 compared
with Q4 2019. Furthermore, VC-funded start-ups do not qualify for
support under current US stimulus programmes for small
businesses.
Capital infusions into smaller companies and start-ups -
especially those directly targeting sustainability issues - are
much more likely to have a rapid additive impact because many
would otherwise disappear for lack of capital. A new breed of VC
and PE funds, such as Berlin-based Moonfare, offer exposure to
smaller, disruptive ESG companies to mass-market investors which
may lack access to the premier funds. Moonfare sets its ante at
€100,000 ($118,594) which can phase in over four years spread
over a number of funds.
However, ESG investors cannot bring about positive system change
by themselves. This will require a partnership between investors,
businesses, and governments working together as “Engaged Societal
Guardians” - perhaps a paradigm for the “New ESG”. Since the
COVID-19 crisis has put societal repair on a critical path to
survival for all three groups, there seems to be an opportunity
to fashion a new collaborative model borne out of enlightened
self-interest.