ESG Investments Post COVID-19: Now More than Ever

In our last blogpost we showed that MSCI ESG indices slightly outperformed during COVID-19, indicating that, even when we face bear markets, sustainable investing continues to be an objectively rational good decision for investors.

In this blogpost, we want to take a closer look at the future outlook of ESG as the international pandemic has caused unprecedented events and disruptions all around the world.

The New Normal

The COVID-19 pandemic serves as the first bear market that ESG has faced, since the trend took off around 10 years ago. This makes it even more interesting to look at how ESG has performed over the past couple of months. In light of ESG investments after COVID-19, experts try to define the future of the “new normal”. A central question is therefore how sustainable investing will develop after the crisis and whether it will fall victim to the survival mode of companies and economies. Many people fear that the previous momentum for environmental, social and governance issues will vanish in the shadow of the virus as economists and politicians state that now employment and people serve as a first priority and that other issues simply therefore cannot be handled. Additionally, the government in France and Germany financially support car purchases – even for fossil fuel consuming cars.

Yet, we have seen a different reality. According to Noel Friedman, the Executive Director of ESG ratings at MSCI, this is not the case as ESG-investing continues to be one of the biggest challenges facing society today as well as in the future. Friedman further emphasizes that as the pandemic has shown to be critical to certain types of firms and changed the way we think about business, it also has the potential to change the way we think about ESG investments. For instance, it emphasizes the importance of ESG being forward looking, in such a way that companies are more resilient and better positioned to handle the exposure to ESG issues.

Furthermore, investors are still betting on ESG and sustainability-focused funds have recorded hundreds of millions of dollars in inflows during Q1 2020, while their counterparts saw billions of dollars flowing out. This is further supported by a recent analysis by Morningstar, where almost all asset prices declined during the initial phase of the coronavirus pandemic, while ESG investments did better than those of conventional peers.

Additionally, there are no signs of restraints of environmental goals by the EU. Last week, The President of the European Central Bank President stated, “We have the opportunity to step up the EU´s efforts to achieve its sustainability efforts by including climate change and sustainability considerations in the financial response to the COVID-19 pandemic.” Denmark has served as the top performing stock market globally this year, positioning a 9.8% gain in U.S dollar terms, according to Bloomberg data. For several years, we have served as a frontrunner in sustainability due to the deeply embedded tradition of pursuing solutions that are sustainable in the long run and incorporating ESG and sustainability at the top of our agenda. Danish companies are global leaders in building eco-friendly businesses, confirming that there is no need to sacrifice returns when investing with an ESG lens.

Increased demand for ESG across all asset classes

Typically, when we talk about ESG, we think about companies and how it is related to the large and global equity markets. Historically, this has been the market where information about ESG has been most disclosed and available. However, over the last five years, there has been a growing demand for ESG data for small cap equity and other asset classes like private equity, hedge funds and real estate. The growing demand is driven by an increase in interest from investors to integrate ESG across all asset classes in their portfolio, and not just in their equity investments. However, this is easier said than done, as there are several challenges in the ESG process when covering those types of markets. With regards to emerging markets, companies are in the need of analysts that understand country specific policies, regulations and the language, along with the need of certain techniques and technologies in order to identify the required data. Nevertheless, as investors are increasingly concerned with expansion of investments into emerging markets, there is a call for improved ESG disclosure and reporting.

Overall, it is clear that the future of ESG investments are bright, as ESG demand is not slowing down.  Most asset managers and companies themselves are increasingly recognizing that effectively managing ESG risk is critical to a company’s survival and not a distraction. To be sure, sustainable equity funds have taken big hits over the past few months, however they have been smaller compared to their peers. Because most ESG funds are less than 10 years old, this is their first test in a bear market, and it is one that they have passed quite well.