A stack of white blocks with orange background

ESG and Sustainability Funds Resilient in the Face of Non-Traditional Risks

July 16, 2020

Throughout the ongoing COVID-19 crisis, major investment funds set up with ESG and sustainability criteria are outperforming the rest of the market, utilizing their experience with non-traditional risks. S&P Global Market Intelligence analyzed 17 exchange-traded and mutual funds, with more than $250 million in ESG-related assets under management, and found 12 of the 17 ESG funds outperformed the S&P 500 this year. ESG fund managers report that their focus on “non-traditional risks” has led to their success.

In a separate analysis of European ESG funds, Morningstar found that during the COVID-19 crisis, ESG funds have not performed as poorly as non-ESG funds. John Streur, the CEO of Calvert Research and Management, one of the largest responsible investment companies in the United States, said companies with a history of managing environmental risks have been relatively resilient during the current crisis. “Although no companies had criteria for how they would respond to a pandemic, it’s clear that companies that had been thoughtful about managing other environmental or social risks were ready for any kind of situation and have reacted quite well,” said Streur.

Focus on non-traditional risks

In the coming decades, responding to emerging business risks will be essential for companies and investors looking to survive and thrive in a climate-adjusted world. Businesses and investors are increasingly developing new tools and capabilities that enable them to pursue sustainable and long-term investing strategies with greater sophistication, reports the World Economic Forum (WEF) in a March 2020 white paper. These include creating dedicated ESG teams that integrate with portfolio managers, ESG and climate scoring and modelling, and the deep integration of ESG into portfolio construction, among others.

Rising climate activism and shifting public opinion

This focus on non-traditional risks has partly been driven by a combination of increasing demand for corporate transparency and rising stakeholder influence. In a hyperconnected and globalized world where activism, news, and access to information is ubiquitous, multiple stakeholders such as non-government organizations, activists, and civil society groups are having an impact on corporate decision-making. Organized campaigns have the means to achieve scale rapidly, creating critical challenges for businesses that previously may not have given them significant attention. In 2019, for example, we witnessed a rise in global activism around climate change, such as the September 2019 global climate marches. These movements have brought an increased reputational risk to companies and put pressure on them to respond.

Figure 1: An example of how ESG issues are impacting businesses

Growing responsiveness of key decision-makers

The growing social, political and economic awareness of the risks of climate change is influencing key decision-makers to act. Take, for example, the global uptake in public issuers disclosing climate-related risks and opportunities in line with the Task Force on Climate-related Financial Disclosures (TCFD) framework.

Since the TCFD released its final recommendations in 2017, support has grown among large, publicly-traded Canadian companies, according to Mantle314’s research for the Chartered Professional Accountants of Canada. As of February 2020, over 1,000 global organizations have also expressed support for the TCFD, representing a market capitalization of over $12 trillion. It is safe to assume that public support for addressing climate change has, in part, led to a change in the way companies think about how it will impact their business. An increase in the disclosure of climate-related risks and opportunities is partly the result of businesses that are increasingly aware of the impacts of climate change, as well as investors seeking to make informed decisions based on transparent and decision-useful information.

Changing expectations and unforeseen events

Companies that remain flexible and adapt to changing societal expectations and the resulting policy responses will be in a better position to succeed. Understanding how to properly assess, manage, and report climate-related risks and opportunities, for example, will be essential as the world continues to grapple with the impacts of climate change. Similar to the current COVID-19 crisis, unforeseen events can have massive and devastating financial impacts on the global economy, exposing the vulnerability of companies that are not adequately prepared.

There are tools available to help companies forecast into the future to project climate-related impacts that could substantially affect their business. CEOs, boards, and senior management can employ climate-related disclosure frameworks, such as the TCFD, in order to understand the impact of climate change on their company’s business and financial planning. As an example, the TCFD specifically calls for companies to use forward-looking scenario analysis to better understand how they will be impacted under different warming scenarios in a climate-adjusted world. “If you feel uncomfortable about your production process or supply chain, there’s probably a reason why,” said Therese Lennehag, head of sustainability at EQT Partners, in the WEF white paper. “In a time of radical transparency, look at your products, practices and your value chain.”