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In John Lennon’s last album in 1980 he released the song Beautiful Boy, which showcased his deep love for his son Sean. The song’s lyrics included the prophetic quote “Life is what happens when you are busy making other plans.” As we struggle to bring into focus the long-term impacts of a post-COVID-19 world, Lennon’s quote is a poignant reminder of the uncertainties that lie ahead for sustainable and responsible investors.
We are now approaching an inflection point in the crisis, where savvy investors are fundamentally reassessing economic, environmental, social and governance factors to adjust to the new normal. Here, I share my perspective on how astute investors can equip themselves for a volatile future by determining whether the companies they hold are future-fit.
Current State of Play
According to Morningstar’s Jon Hale, funds that integrate environmental, social and/or governance factors registered record growth in Q1 2020, eclipsing the previous record in Q4 2019. “Sustainable funds in the US set a record for flows in the first quarter”, wrote Hale. “ETFs, passive funds and iShares dominate as US ESG funds gather $10.5bn in the first quarter.”
What’s more, evidence suggests that ESG-attuned funds were ‘sticky’ and held their value relative to their benchmarks. This early signal bodes well for sustainable investors and could serve as a proof point for how investors can trust ESG funds in turbulent markets.
Many investors are now reimagining the future state of investing in the aftermath of the pandemic. Important considerations come into play in preparing for the future, such as: What does the US government’s current response to the crisis portend for the economy over the next three years? How do we know if a company is resilient and positioned for growth over the long term? And, do we have the information we need now to evaluate companies’ long-term performance outlook?
Predictions for the future: Six emerging mega-trends in the US
Over the next 12 to 36 months, the following six mega-trends promise to reshape the business practices and investing:
1. Record deficits squeeze companies that rely on government funding
In 2021, political and financial market pressure for deficit reduction will mount as markets adjust to the economic realities resulting from the record stimulus. This will adversely impact companies that rely on government funding as budgets are slashed in an effort to stabilise the economy.
2. Inflation roars as a result of unprecedented global stimulus and quantitative easing
As of April 2020, the first wave of COVID-19 stimulus and quantitative easing surpassed $2trn, three times the amount of the 2008 financial crisis bailout and more than five times the amount of President Obama’s 2009 stimulus. The likely result of the most extensive bailout in US history is that inflation rates will soar, perhaps eclipsing 10%, similar to what the US experienced in the early 1970’s.
3. Commercial real estate bubble emerges as a result of record levels of small businesses closures
As of today, over 50% of all stores in the US are closed. Government support will help, but will not be enough or come fast enough to prevent a commercial real estate bubble in the US. What’s more, the growth of online shopping will continue to accelerate, exacerbating pressure on brick and mortar commerce.
4. Unemployment hovers around ten percent for a sustained period
In mid-April, unemployment claims in the US jumped to 26 million, which is more than the total number of jobs created over the last ten years. This translates into an unemployment rate of approximately 16%. The unemployment rate should level off at around 10% within twelve months, but we are in for a period of sustained high unemployment rates for the foreseeable future in the US.
5. “Multiple capitals thinking” begins to transform investment decision making
The recent $2trn stimulus includes a $500bn bailout for companies that were hardest hit by the pandemic. Many progressive thought leaders, such as American Prospect’s David Dayen, objected to the bailout on the grounds that these corporations wouldn’t need it if they hadn’t “squandered their record-high profits on payouts to CEOs and shareholders”. As a result, a new way of thinking is emerging that is transforming the way we value a company’s relationship with nature, people, society and shareholders. This ‘Capitals Thinking’ approach is being championed by the Capitals Coalition and aims to reshape how investors engage on corporate governance and value the relationship between commerce, people and nature.
6. Sustainable (ESG) investing becomes the new normal in the US
Within 36 months there will no longer be a discernable distinction between sustainable and traditional investing. As sustainable investing continues to scale and become infused in Main street and Wall Street, high-quality investment managers will utilise “multiple capitals thinking” and integrate financially material ESG considerations in engagement strategies and investment decision making. This will be the silver lining of the crisis.
Call to Action
Collectively, these mega-trends – each with a distinct but linked role in the emerging investment landscape – will:
Transform the way corporate sustainability information is utilised by developing new disclosure expectations for material sustainability information and value generating strategies based on existing standards;
Reposition corporate reporting to tell a more complete story of how an organisation’s strategy, governance, performance and products lead to the creation of value over the short, medium and long term, through a “multiple capitals” prism;
Improve the precision, materiality and disclosure of sector-based sustainability and ESG KPIs and accounting metrics;
Accelerate the integration of ESG factors into investment and credit rating decision making.
The time has passed for small commitments, hyperbole and delays in embracing sustainable investing. Now is the time for leadership, investment and action. Companies and investment managers that remain on the sidelines will sacrifice their opportunity to shape their own, and the planet’s, future.
Mark Tulay is Founder and CEO of Sustainability Risk Advisors