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Over the past couple of years, ESG was one of the most hyped terms in the investment space. Standing for Environmental, Social, and Corporate Governance, ESG refers to the three central factors in measuring the sustainability and societal impact of an investment in a company or business. It not only represented a new form of investing that was kinder to the planet and more ethical at a societal level but also promised greater returns than traditional investment procedures.
The majority of ESG funds outperformed the wider market over 10 years, according to research from data provider Morningstar. This is illustrative of the fact that ESG factors are not just “nice-to-haves”, but drivers of performance. Small wonder then that ESG funds reached an all-time high of $960 billion at the end of 2019.
Of course, the ESG space took a hit as COVID-19 became widespread, but so did all other forms of investment. And as markets stabilise and economies look to recover, we can expect to see ESG return to the spotlight in a big way. That’s not just because the pandemic and its associated lockdowns have made investors rethink how they’ve always done things (although that may be true for some). It’s also because ESG investing offers the best path to economic recovery.
Resilience
As a recent research paper by EY points out, ESG funds outperformed classic indices like the S&P 500 during the first weeks of the crisis, and several ESG funds were able to soften the blow to loss in value compared to standard non-ESG benchmarks.
That’s no accident. When you look at the companies that fit best into ESG funds, they’re also less likely to be impacted by a crisis like COVID-19. If they’re environmentally sustainable, they’re less likely to be dependent on carbon-heavy international supply chains. And if they’re socially responsible and have good governance, they’re less likely to put themselves in a situation where they’re crippled because of an outbreak among their workers or are shut down for flouting government rules and regulations.
As EY notes, “High social standards and good company governance emerged as key indicators of resilience against the pandemic’s impact at both country and company level”. By taking the same long-term approach as these companies and investing in them, investors can insulate themselves against future economic shocks. And there will be more such events in the future. They might not always come in the shape of a pandemic, but natural disasters brought on by climate change and other economic disruptions can be just as devastating.
Resurgence
Thanks to this resilience, companies with strong ESG credentials will be better positioned for resurgence than others as economies bounce back. This will, in turn, benefit the funds that invest in them.
It’s also worth noting that governments around the world are starting to understand the importance of ESG in the wake of COVID-19. For example, the proposed EU Recovery Funds that are meant to restore the COVID-19-affected EU economy are designed with an emphasis on long-term projects that meet specific climate and energy plan criteria. And if Joe Biden wins the US presidential election in November, it’s likely that some form of “Green New Deal” will form part of his policy agenda. It’s likely therefore that the ESG environment will be more fertile than ever over the coming months.
Beyond the ‘E’
When it comes to ESG investing, it’s all too easy to focus on the environmental pillar. In part, that’s because the environmental data is much easier to obtain than social and corporate governance data. But, it’s also true that environmental concerns are an easier sell. It’s much easier to make an investor understand a new wind farm or a technology for removing plastic from the ocean than it is to get them excited about the social good a company does or its exceptional levels of good governance.
But if investors are serious about ESG, they cannot afford to ignore these important factors. In Africa in particular, investors should pay attention to female representation and ownership of the companies and projects they invest in. It is, of course, something they should always have been doing, but is even more critical in the wake of COVID-19.
The pandemic and its associated lockdowns have hit women-owned businesses particularly hard. According to research from the African Development Bank’s Affirmative Finance Action for Women in Africa (AFAWA) programme, women-led businesses across the continent have faced closure at much higher rates than those of their male counterparts. The main drivers of this disparity include limited access to finance, shifts in consumer behaviour, and increased household care responsibilities as a result of extended lockdowns.
We cannot hope for real post-pandemic recovery unless that situation is reversed. There is a clear link between gender-diverse companies and financial performance. And at a macro level, if women participated in economies at the same levels as men, it would add US$28-trillion to the global economy. Moreover, investors are missing out on a whole load of potential returns if they fail to invest in companies that are owned by, or empower, women.
Perfectly pithed for South Africa
Finally, it’s important to note that South Africa is an ideal environment for ESG investing. Not only can this type of funding make a major difference here, but the overall regulatory regime is welcoming to it too.
As an article in Responsible Investor points out, South Africa has long been seen as “one of the most advanced jurisdictions in the world in terms of ESG, with initiatives such as the King Code on corporate governance and the Code for Responsible Investing in South Africa (CRISA) rightly seen as leading the way”.
From an environmental perspective, it’s increasingly becoming clear that renewable energy offers the best possible way out of the country’s energy crisis, and that there’s a clear need for innovation around water management (in fact, the country is already a leader on this front). Even if initiatives in these sectors aren’t funded at a state level, there is a growing appetite for them in the private sector.
And with ESG focus on social impact, investments in such projects can help create lasting employment in the communities where they’re needed the most. That, in turn, helps solve two perennial bugbears of infrastructure projects: that they don’t create lasting jobs and that the jobs don’t serve the communities around them. To help illustrate this, at Thuso Partners we construct our portfolios through the lens of the “ESG mindset” and our investors and other stakeholders are able to observe and measure both the impact and returns of our actions.
South Africa’s GDP has contracted more than 50% in Q2 and so the focus urgently needs to turn to recovery. It’s already clear that the state’s approach will be infrastructure heavy. How much of an ESG-type approach it takes remains to be seen?
It’s important to remember that the Government can only do so much, however. Private investors will also play an important role in the country’s recovery. And, by adopting an ESG-based approach, they won’t only make the country (and the planet) a better place in the long term but will also net serious returns.
Author overview
Mmitji Letsoalo is a Portfolio Risk Professional with a strong background in the development, implementation and maintenance of asset management risk systems. Mmitji is a key part of the Thuso Partners team transforming the private market landscape in South Africa. He continues to build on his experience and expertise in asset management through the creation of high-quality portfolios and teams. ESG implementation lies at the core of Thuso Partners’ day-to-day functioning to ensure that they offer a diverse skillset and remain at the height of excellent business monitoring.