ESG Doomsday Preppers

By Alison Lee 15 May, 2020

Many laughed at Doomsday preppers but who is laughing now as companies integrating ESG outperform during the crisis? ADMCF's Lee expands

COVID-19 showed how fragile our economic structure is, forcing investors to re-evaluate their portfolio strategies & companies worldwide to look at risks caused by nature
Stocks with high ESG grades in APAC outperformed their region's index by 9.6% but ESG isn't perfect due to data limitations, different definitions & the need to navigate the KPI alphabet soup
Companies integrating ESG issues are typically more prepared for unforeseen external risks; We can’t just stay home & avoid the climate crisis, so start looking at ESG now to dodge Doomsday

When the TV show ‘Doomsday Preppers’ came out in 2011, we all thought stockpiling food was really stupid, but who is laughing now? COVID-19 has shocked our world by highlighting how fragile our social, economic and political structure is. It is forcing investors to re-evaluate their portfolio strategies and companies worldwide to look at risks caused by nature. It also provides us with a neat acid test to examine the effectiveness of ESG.

In many ways, us ESG people are also Doomsday Preppers. We are doing a lot of tedious work to help prepare for the worse-case-scenario and some may roll their eyes but don’t come to us for toilet paper when you run out!

ESG is doing ‘good’ by being ‘good’?

There have been numerous examples showcasing the positive performance of ESG during the time of the crisis.

During this crisis, stocks with high ESG grades outperformed their region’s index by 9.6% in APAC

For example: Morningstar analysed the returns of 206 sustainable US equity open-end and exchange-traded funds and found that in the first quarter of 2020, 44% of sustainable equity funds ranked in the top quartile of returns, 70% ranked in the top half while 11% ranked in the bottom quartile. HSBC also analysed stocks with the top ESG scores and found that those with high ESG grades outperformed their region’s index by 9.6% in Asia-Pacific since mid-February. Not too shabby! This is perhaps unsurprising as ESG investors tend to shy away from the energy sector, which has been one of the most affected by quarantine rules, and favour more COVID-19 resilient sectors such as technology and healthcare.

Zombies ahead! Beware of ESG’s limitations

However, it is critical to recognise that stocks selected for these ESG funds can be a little biased at times. ESG as defined by each fund may differ and priorities for certain metrics such as labour practices maybe overlooked, while carbon metrics may take precedent if there are some firm wide or fund KPI requirements.

What constitutes a ‘top ESG’ performer is still questionable due to limited & inconsistent data

A popular example is Amazon, a common stock held by numerous large sustainable funds thanks to their efforts in purchasing renewable energy and their climate pledges, although MSCI provided them with a poor rating on labour management. Furthermore, what constitutes as a ‘top ESG’ performer is still questionable, as data availability is still limited. The inconsistency of ESG scores across multiple data providers is also an issue which has resulted in scope, weight and measurement divergences (there is a MIT study all about that!).

Navigating the alphabet soup – I think ESG is giving me acid-reflux

Let’s not forget about the lack of ‘harmonisation’ of standards, navigating the ESG alphabet soup is a tough task! In my experience, for some private credit deals even SASB’s 77 industries across 11 sectors is not comprehensive enough.

Take the Real Estate sector for example, it could be broken down even further into 3 different stages of business cycle – such as construction, use-phase and post use/ retrofit because they are all very different things! I am not complaining though, SASB is doing a great job and it’s already pretty granular.

On top of that,  there is also the mothership of standards such as the IFC Performance Standards on which most Environmental, Social Action Plans are based on. Then you may want to set KPIs to ensure alignment and (hopefully) contribution to SDGs. Plus there’s the EU Taxonomy and TCFD to worry about. Are you getting acid-reflux from the soup yet?

Light at the end of the tunnel

With caution and the alphabet jumble aside, the core of ESG investing assumes that ESG factors are material risks.

As a result, due diligence effort on risks go beyond the financials alone and a more long-term approach is applied over short-term gains, which is a good thing. If we look at material risks identified by SASB it encourages us to look into metrics such as ‘Supply Chain Management’, ‘Critical Incident Risk Management’, ‘Labour Practices’, and ‘Systemic Risk Management’.

These metrics can guide companies to look into business models and governance measures to mitigate risks currently caused by COVID-19. More specifically, for ‘Workforce Health & Safety’, the accounting metric even includes effort to assess, monitor and mitigate acute and chronic respiratory conditions for some sectors such as ‘Meat, Poultry & Dairy’. A spooky foreshadowing of what companies are doing during the pandemic.

Companies integrating ESG issues are typically more prepared for unforeseen external risks

Companies integrating ESG issues are typically just more prepared for unforeseen external risks such as a pandemic, not just climate risks. All the different ESG standards are pretty helpful when trying to figure out potential material risks even though they are awfully messy at the moment. By preparing diligently, we are preventing Doomsday.

Hello? Is it ‘E’ you’re looking for?

‘E’ as in Environment okay? Due to the nature of the pandemic, companies naturally shift their focus to the ‘S’ and ‘G’ but have they swept ‘E’ under the rug?

According to an article by the Wall Street Journal, numerous MNCs have put a break on their green commitments. For example, Unilever has pressed pause on a number of its “Change Initiative” projects. Ford Motors, on the other hand, has abandoned an electric car project. This is likely caused by the company’s financial position being tested while priorities are shifted.

Numerous MNCs have put a break on their green commitments…

…Also, the US EPA gave a pass to co’s on air & water pollution

But on the other side of the spectrum, we see climate pledges continue to grow from MNCs with General Mills pledging to source 100% renewable energy by 2030 and joining the RE100 in April. Evian also went carbon neutral globally in April and was certified by the Carbon Trust. However, it is important to always be on the side of caution as pledges and certifications don’t always mean that climate actions materialise.

We have also witnessed some extraordinary negative ‘E’ actions in the policy space, with the United States Environmental Protection Agency relaxing pollution regulations during the pandemic and allowing US companies to not face sanctions for air and water pollution. Unsure if this is to create more jobs or make people cough more thanks to more pollution during a respiratory pandemic?

With these confusing policies aside, a unified global crisis has exposed how inefficient we are at managing risks, but it doesn’t need to be this way.

But ‘E’ is critical, its poor management caused the pandemic

We also shouldn’t ignore the fact that the pandemic was caused by poor management of ‘E’, resulting in zoonotic transmission of a virus between wildlife and humans. If we refer back to SASB, it highlights issues such as ‘Ecological Impacts’ (which includes biodiversity and deforestation), “Animal Care & Welfare” and ‘Waste & Hazardous Material Management’.

Our poor management and ever-closer relationship with nature and animals should have already been looked at as a material risk in the first place. For example, at the Tropical Landscapes Finance Facility, we strive to achieve positive impact for communities and the environment through all our investments. Our impact objectives include: forest retention, improved rural livelihoods, peatland restoration, sustainable supply chains, clean energy, reduced emissions, biodiversity protection and pollution reduction. Long list and tough work but it’s worth it!

Crawling out of the bunker

Delayed action to mitigate the spread of COVID-19 has made flattening the infection curve a lot trickier, mirroring the difficulties of flattening our mitigation pathway. Change in climate has already started to affect company performance, according to S&P 15% of companies in the S&P 500 index already disclosed that weather events such as drought, cold snaps and excessive rainfall had impacted their revenue between April 2017 and April 2018.

We can’t just stay home with the climate crisis, so start looking at ESG now

With the climate crisis we can’t stay home and wait for it to be over and there is no magic vaccine to make us immune to the impact. So why not just start looking at ESG risks (and opportunities!) now and prevent Doomsday from happening!

P.S. Doomsday prevention is only phase one, the next step will be to measure the elusive ‘ESG impact ghost’ whether it is negative or positive, to determine ESG’s real contribution.

Further Reading

  • Where Is The E In ESG Disclosure In China? – China is moving to mandatory environmental disclosure with a tentative 2020 deadline, but where are listco’s now? China Water Risk’s Dawn McGregor & SynTao’s Dr. Peiyuan Guo share 8 key takeaways from their newly released joint report, “CHINA PRIORITISES ENVIRONMENT: More Disclosure Needed To Match Rising Risks”
  • Connecting Finance & Water Risk – Natural Capital Coalition’s Mark Gough & Joseph Harris-Confino on their newly launched supplement for the finance sector – see how can this help bankers, investors and insurers alike amidst increasing ESG adoption
  • How To Manage Water Risk In Your Growing Business – Water risk is financial risk. So how do investors and business overcome challenges and manage water risk? Trucost’s Byford Tsang and Rochelle March expand and also share the benefits
  • Environmental Risks: What, Where & When? – Hubert Thieriot explains his new venture, Environmental Risk Profiler, an online solution to identify, monitor and anticipate environmental risks – find out how it works

More on Latest

  • Capital Threats Remain Post COVID – There is no vaccine for climate & water risks, yet some in the financial sector are still burying their heads. CWR’s Dharisho Mirando reminds us how our capital is at risk & steps we can take to reduce them while going green
  • The Future Of Finance – HKGFA’s Dr. Ma Jun believes in post-COVID times, investors & bankers should expect more emphasis on environmental disclosure by regulators, which will pave the way for higher quality green finance products
  • Top 10 Responsible Investment Trends In China In 2020 – With their finger on the pulse, SynTao Green Finance runs through 10 key trends on responsible investing in China in 2020
  • Asia, Why On Earth Would We Leave Our Future To G7? – With G7’s absent leadership & inability to plan for pandemics, CWR’s Debra Tan calls for Asia to step-up & lead the global fight against our climate crises. Tycoons, think about it – what’s the point of building empires that will kill your grandchildren?
  • 8 Risks You Missed During COVID-19 – Been focused on COVID-19? You are not alone but we can’t get distracted from the climate crisis. Catch-up with CWR’s Chien Tat Low who runs through 8 latest climate & water risks
Alison Lee
Author: Alison Lee
Alison Lee is a Tropical Landscapes Finance Facility (TLFF) Analyst for ADM Capital Foundation and provides ESG integration advice for ADM Capital funds. Alison co-developed ADM Capital’s proprietary ESG toolkit that has been rolled out to all ADM Capital’s analysts. She was involved in various aspects of ADM Capital’s role in the US$95 million TLFF financing of PT Royal Lestari Utama’s sustainable rubber plantations in Indonesia. Post investment, Alison has been deeply involved in monitoring and reporting on ESG issues linked to the project. Prior to joining ADMCF she was an Equity Research Associate at CLSA covering Hong Kong discretionary consumer and China education listed equities. She has a BA (Hons) from The University of Strathclyde Business School in International Business and an MSc from The University of Manchester in Industrial Relations.
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