Markets have grown a conscience.
Environmental, social and governance factors have been dominant forces at the midyear mark.
Check out these stats:
- 14 out of 17 ESG-focused ETFs and funds outperformed the S&P 500 from January 1 to May 15, according to S&P Global Market Intelligence.
- Morningstar says 23 new ESG funds launched this year and anticipates a record number of launches in 2020.
- And, U.S. sustainable funds hit record net flows in 2019, four times the previous high, according to Morningstar. This year is already on track to surpass last year.
The drivers in 2020 are clear. The most obvious example is the collective response to the Covid-19 pandemic, which has compromised our interconnected world. Social inequality has also come to the fore amid civic protest and global unrest. What this first half of the year tells us is that ESG risks increasingly are playing a central role across the entire investment landscape.
In combating the coronavirus, for example, most governments essentially closed their economies to mitigate its spread and save lives, arguably resulting in the most monumental "S" (social) impact in decades. Further, the aggressive use of fiscal and monetary support to help individuals and companies financially survive was not just a matter of necessity but also social responsibility. "G" (governance) also comes into play here, as the structure of various political systems around the world have allowed certain countries to respond more robustly in terms of health, fiscal and monetary policy relative to their peers.
Looking forward, social and governance considerations likely will take on even greater importance as governments and societies seek to refine the balance between safety, individual freedom, privacy and growth.
How the public and private sectors react to the issues surrounding racial disparity in the wake of continuing demonstrations across the globe clearly will have an impact on redefining our social contract. When combined with the ramifications of Covid-19, the lack of preparedness to manage the well-being and equality of many communities is at some level a failure of governance and social responsibility.
Part of good governance at the company level is proactive risk management and emergency preparedness, along with an implicit or explicit social contract supportive of employees and communities. Similarly, the success or failure of certain companies is being determined by their ability to have sound business continuity plans and purposeful leadership. Some companies and governments have demonstrated their resilience and are adapting well, but many were so blindsided they may need to hit the reset button.
Tensions with China also are tied to ESG concerns even if market participants fail to make that direct connection. The very origins of the pandemic may be related to improper environmental and/or safety policies, and the lack of transparency with regards to the magnitude of the growing epidemic during the early days of the outbreak showcased the need for disclosure on social factors. Longer term, trade tensions continue to be of great concern regarding intellectual property protection ("S"), privacy protections ("S"), human rights issues ("S") and environmental concerns ("E"). Continued sociopolitical unrest in Hong Kong also represents issues of social accountability, with the commercial consequence being the potential delisting of major Chinese companies on U.S. stock exchanges.
As all of the above attests, the days of responsible investing simply being a subset of investors seeking to "do good'' have long past. These days, keeping a finger on the ESG pulse of regions, countries, sectors and companies can be critical to understanding risks and opportunities in a portfolio.
As we reflect on the first half of 2020, it's clear that ESG factors represent prudent macro risk considerations that should be taken into account when seeking long-term value creation. In fact, according to our proprietary ESG data as well as third-party scores, year-to-date, S&P 500 constituents in the top-quintile of social sustainability have outperformed the bottom-quintile social laggards.
With the year's second half underway, there may be no better argument to "think" ESG.
Steve Chiavarone is portfolio manager and equity strategist at Federated Hermes. Martin Jarzebowski is director of responsible investing at Federated Hermes.
Federated Hermes, Inc. is a leading global asset manager focused on meeting the diverse and evolving needs of today's investors. It has $605.8 billion in assets under management.