Let’s Not Get Carried Away, This is Still Early in the Match
Sean Griffin responds to Jakob Thomä’s recent article on the end of ESG
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The June 9th article Is COVID19 the end of ESG and the beginning of existential risk management? conflates a wide number of concepts which lead to a conclusion that at best is not helpful and at worst will confuse the wider audience further.
Firstly, we must accept that ESG as a risk management framework has exploded in the last 18-24 months. Is there a money manager that doesn’t talk about it when pitching clients or an asset owner that doesn’t ask about it when vetting managers? We have gone from the wilderness to primetime, but is everyone ready?
To the extent that all money managers and asset owners are required to give it at least lip service, we are overestimating the rigour and robustness of aggregate ESG expertise. This creates a hugely uneven playing field in the application of the related concepts to how managers assess risk and structure their portfolios. This is not an inherent flaw in the frameworks, rather it reflects a field still in its infancy, despite what feels like a day in the sun for those of us who have been focused on sustainability disclosure for years.
"The call to arms is not for a new framework, but rather for those involved to use more imagination in understanding relevant risk factors and undertaking assessments with the tools they have"
Stating this is critical to have a shared understanding of the reality of ESG integration into existing risk management practices. It should come as no surprise that those learning the power of considering risk holistically, not just from a strict operational or financial lens, were caught off guard. Even many ESG experts are grappling with the most efficient ways to integrate these risk factors into their overall evaluations and ultimate allocations. We must remember this shift is about more than just ESG funds.
Secondly, it is inappropriate to suggest any risk management framework would cushion global markets and investors from a multiple-month long reduction in global commerce like we have seen. We must not pretend any framework will eliminate risk exposure or should be expected to anticipate all possibilities. After all, the corollary to return is risk. Further, on a probability basis, it might not have been reasonable to position for the risk of a pandemic, no matter how long back we can find a video of Bill Gates saying a pandemic was one of the greatest risks to humans.
There were few incentives coming into 2020 for corporates to hoard cash, just in case. This again is a failure for the concepts to be applied broadly, not a fatal flaw of an emerging way to manage risk.
This leads into a related point that for those focused on risk management, the COVID-19 pandemic and the eventual global response was anticipated early enough to position portfolios accordingly. Hedge fund manager Erik Townsend provides a handy timestamped tweet so that we cannot retroactively forget the risk was known and collectively the world shrugged.
Third, let’s not mismatch time horizons. ESG as a holistic risk management tool is necessarily long-term focused. As such, it’s inappropriate to compare immediate returns in the still-beating heart of a crisis. A global sell-off of the nature we experienced and may experience further is bound to impact all, except to some extent those whose business by nature benefits from this event (e.g. Zoom). The pandemic might lead to a complete repricing of risk assets, which says only that existing baseline multiples may no longer be fit for the years to come.
The proof of ESG as a path forward will be in the longer-term performance once we have exited the acute crisis and businesses are operating under less pandemic-related uncertainty. Again, these frameworks will never protect against a broad global sell-off, but if ESG frameworks are capable of what supporters believe, then we should see relative outperformance and even absolute strong performance from those corporates who are better managers of ESG factors.
Let’s see if companies with stronger governance practices, that are more able to adapt to changes in the social and physical environment, outperform in the next decade before getting excited about new things. I’m willing to wager they do, because the pandemic is not the only change happening in the world today.
Lastly, for the more advanced, the ESG conceptual frameworks were capable of preparing for something like this. There is no excuse for an interruption to, or shutdown of, global travel to not be a considered risk for the travel and tourism industry. It does not take much to imagine a scenario whereby an airline’s ability to generate revenues would be completely negated by terrorism, geopolitical tensions or a pandemic.
Acknowledging this risk would have led to more robust questioning around cash reserves and cost flexibility at airlines for instance. We could go in-depth on this as there are numerous ESG gaps that point to inadequate preparation by many of the publicly-traded companies most seriously impacted.
That said, even identifying the risk does not mean on a probability adjusted basis it makes sense to position ahead of it for either the company or investors. These types of decisions need to be consistent with that organisation’s tolerance of risk and volatility. Access to the same information does not mean we all reach the same conclusion.
The call to arms is not for a new framework, but rather for those involved to use more imagination in understanding relevant risk factors and undertaking assessments with the tools they have. This is a tremendous opportunity for an emerging field to demonstrate its flexibility and applicability, as long as we do not needlessly change expectations so early in the effort.
Sean Griffin works in corporate communications and has spent more than 15 years advising c-suite leaders on reputational risk and sustainability