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The new normal in sustainable investing post-COVID-19

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 to you while you’re 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 corporate sustainability executives and investors. 

We are 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. Many investment firms are modifying their strategies and valuation models over the long-term in the wake of the pandemic.

Here’s 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 (ESG) factors registered record growth in Q1 2020 that eclipsed the previous watershed moment in Q4 2019. “Sustainable funds in the United States set a record for flows in the first quarter [of 2020],” wrote Hale. “ETFs, passive funds and iShares dominate as U.S. ESG funds gather $10.5 billion in the first quarter.”

What’s more, anecdotal 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 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 U.S. 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 to evaluate companies’ long-term performance outlook? 

Emerging megatrends in the U.S.

Over the next 12 to 36 months, the following six megatrends promise to reshape the business practices and investing:

1. Deficits squeeze firms relying on government procurement

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 affect companies that rely on government funding as budgets are slashed in an effort to stabilize the economy.

2. Inflation roars as a result of stimulus and quantitative easing

As of April, the first wave of COVID-19 stimulus and quantitative easing surpassed $2 trillion, three times the amount of the 2008 financial crisis bailout and more than five times the amount of President Barack Obama’s 2009 stimulus. The likely result of the most extensive bailout in U.S. history is that inflation rates will soar, perhaps eclipsing 10 percent, similar to what the nation experienced in the early 1970s. Companies unable to adapt quickly to inflation will be adversely affected in this new economy.

3. Commercial real estate bubble emerges from business closures

One prominent economist reported that bars in the U.S. had, on average, enough cash cushion to sustain closure for only 22 days. And as of today, over 50 percent of all stores in the U.S. are closed. Government support will help but will not be enough or come fast enough to prevent a commercial real estate bubble. What’s more, the growth of online shopping will continue to accelerate, exacerbating pressure on brick-and-mortar commerce.

4. Unemployment lingers at around 10 percent 

In mid-April, unemployment claims jumped again as COVID-19 virus toll reached 22 million, more than the total number of jobs created over the last 10 years. This translates into an unemployment rate of about 16 percent. This should level off around 10 percent within 12 months, but we are in for a period of sustained high unemployment rates for the foreseeable future.

5. Multiple capitals thinking transforms decision making

The recent $2 trillion stimulus also includes a $500 billion bailout for companies 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 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. ESG investing becomes the new normal

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 on Main Street and Wall Street, high-quality investment managers will use 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. 

Collectively these megatrends, each with a distinct but linked role in the emerging investment landscape, will:

  • transform the way corporate sustainability information is used 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 organization’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 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.

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Communicating across the chasm: How companies can navigate the new investor ESG landscape

Two weeks ago, I joined 200 sustainability, finance and investment leaders at the second annual GreenFin Summit during GreenBiz 20, where attendees forged critical connections between the investment and sustainability communities. 

While many companies have been tackling environmental, social and governance (ESG) issues for decades, investors are newly incentivized to incorporate sustainability into their own business models, products and services — demonstrated by a flood of recent announcements from institutional investors such as BlackRock and State Street and underscored by unlikely pundits such as Jim Cramer.

Edelman’s 2020 Trust Barometer finds that 56 percent of people think capitalism does more harm than good in the world today, and Nasdaq President and CEO Adena Friedman has declared 2020 as the tipping point for ESG.

We’ve reached peak hype on investors and ESG. But now it’s time to convert hype into reality, and companies and investors are fumbling for solutions as they navigate toward a vision for better capitalism.

What will it take to align and leverage capital markets to drive the global economy toward sustainability? How are investors using ESG data and ratings in decision-making? And how should they communicate sustainability leadership to important audiences?

Here are three of my takeaways from the conversation for companies seeking to align and engage successfully in the new world of stakeholder capitalism.

Finance and sustainability leaders are still learning each other’s languages

Like tweens at a middle school dance, finance and sustainability are in the same gymnasium but still unsure of the best way to interact.

Awkward differences between the two worlds are exacerbated by the fact that there is currently no standard framework for ESG data reporting despite the existence of protocols from the Global Reporting Initiative (GRI), The Sustainability Accounting Standards Board (SASB), and the Task Force for Climate-related Financial Disclosures (TCFD). For now, companies should focus on creating connections and fluency between finance and sustainability functions within the corporate organization.

One head of sustainability for a global food company tracks the number and nature of investor inquiries on ESG to influence and communicate with the C-suite. This has helped her move the needle on sustainability funding and measurement and disclosure.

Another theme discussed at the summit was internal alignment. While we know that many sustainability executives already join investor calls when needed, many companies attending the GreenFin Summit noted they have formed robust internal ESG working groups composed of corporate social responsibility, risk and compliance, finance and investor relations to develop the muscle to engage on ESG proactively.

For those looking to gain buy-in from CFOs, the Accounting for Sustainability CFO Leadership Network provides resources, TCFD workshops and ESG case studies written “for finance by finance.”

Perhaps the holy grail of internal ESG alignment is Equinix: Katrina Rymill’s role as vice president of IR and sustainability at the data center company is the ultimate expression of ESG virtues. These examples from the GreenFin Summit are a few pragmatic steps companies can take to better integrate their finance and sustainability functions.

Own your own narrative

Disclosure and transparency no longer will be optional. As markets continue to debate the best ways to set up policies, standards and regulations for ESG disclosures, investors aren’t waiting for a perfect system. They’re already forging ahead with assessments that are affecting investment prospects and cost of capital for companies.

Investors — from the biggest institutional investors to small investment management firms — have developed custom models to assess ESG performance.

For example, State Street’s “R-factor” combines Sustainalytics, ISS-ESG, Vigeo-EIRIS and ISS-Governance ratings with a proprietary house blend of analysis and algorithms.

Why does this matter? Many companies (and in particular, CFOs) may not be aware of the importance of environmental and societal stewardship and how it affects investor decision-making — and ultimately reputation and stock price. Equinix was turned down by an investor in Europe due to a low Sustainalytics rating.

Another summit attendee from a medical device firm noted it had received a low ESG rating, not because of poor performance, but simply because it had not reported one key metric. General Motors — a leader in ESG disclosures — found outdated information on MSCI, an index investors use to assess ESG management.

Companies should understand their ratings and correct them or supply more disclosures if needed. In addition to disclosing data, investors are also looking for context to help them understand how the numbers fit into corporate strategy.

Here lies the opportunity for companies to communicate with investors. This engagement and disclosure can drive positive action on sustainability across the organization that will be rewarded by the capital markets and employees, and will better meet the new expectations under stakeholder capitalism.

Evolve external and internal communications

Investors, employees and society are all hungry for better communications on how companies are addressing ESG. The term ESG was used during 100 percent more S&P 500 corporate earnings calls in the second quarter of 2019 compared with the first quarter, according to FactSet.

GreenFin Summit attendees noted that incorporating sustainability into analyst days is becoming the norm. In order to be fully prepared, be sure that executives beyond the head of sustainability are prepared to speak to your corporate ESG strategies with attending analysts, media and industry stakeholders.

Greenwashing is another major concern. Because ESG investing is still relatively new, the ability of shareholders, investment managers and individual investors to judge the meaningfulness of various ESG factors is still evolving.

Vanguard and others in the retail investment space have been criticized for rushing to market with ESG funds and dedicating fanfare to portfolios that included many non-ESG friendly stocks. Corporate communications executives should work closely with sustainability and finance functions, credible ESG thought leaders and third-party experts to position any claims or to bring new ESG products, services and initiatives to market to ensure trust with key stakeholders is not broken.

Lastly, companies must communicate more authentically with employees. As seen with Amazon’s employee climate protests and highly publicized shareholder resolution, employees are critical actors when it comes to engaging on ESG.

Leading companies engage employees proactively and enlist them in the stewardship of environmental and social outcomes. At a minimum, this includes sharing information with all employees on how the company is performing, explaining the ESG strategy and how employees can help drive it and acknowledging any tradeoffs and considerations.

Just like any other major corporate transformation, employees will need to be more fluent in ESG in order for the company to deliver against ambitions sustainability and social targets.

Hope for the future of stakeholder capitalism

Just as environmental, social and governance stewardship is not a new concept to the corporate sustainability community, the investor community has its own tried-and-true precedent to rely on: the basic principle of sound financial management.

Someday the markets may think about ESG the way Mark McDivitt, managing director and global head of ESG at State Street, summed it up best: “Forget the term ESG. It’s just 21st century alpha.” 

Maybe the chasm between corporate sustainability and investors isn’t as wide as we think.


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On the money: 8 takeaways from the 2020 GreenFin Summit

The second annual GreenFin Summit, part of GreenBiz 20, brought together 200 sustainability and investment professionals representing $22 trillion in assets under management and more than 50 Fortune 500 companies.

The focal question: What would it take to align and leverage capital markets to drive the global economy towards sustainability?

This question comes at a critical time. Integrating ESG data into investment decisions has moved from the margins to the mainstream and is now top of mind on Wall Street. ESG considerations are being factored into a growing number of investment managers’ portfolios, indices and engagement strategies, integrating traditional financial metrics with such financially material criteria as climate change and human capital.

As a result, corporate sustainability executives are engaging in vital new dialogues with their internal colleagues in investor relations, treasury and governance and are increasingly interacting with fund and index managers that hold stock in their company.

The invitation-only GreenFin Summit, presented by GreenBiz in partnership with Trucost, part of S&P Global, yielded a lively discourse that was by turns encouraging and frustratingly familiar. In some ways, it seemed to tread old ground, rehashing conversations of 15 years ago with little apparent progress. At the same time, the consensus seemed to be that we have rounded a corner and that something has shaken loose to propel real action.

This is the day after “Groundhog Day” — a reference to the 1993 Bill Murray movie — the beginning of a decade of change, said one participant. Many in the room felt that we’ve seen seismic moves just in the last few weeks from unexpected corners that are reimagining the role environmental and social issues play in financial markets. In January, for example, BlackRock CEO Larry Fink asked companies in his annual letter to explain what social purpose they serve and outlined a stronger stance on ESG issues in general and climate risk in particular. A couple weeks later, State Street Global Advisors (SSGA) CEO Cyrus Taraporevala conveyed in his letter that ESG is no longer optional, and that “we are prepared to use our proxy voting power to ensure companies are identifying material ESG issues and incorporating the implications into their long-term strategy.”

Also last month, Bank of America CEO Brian Moynihan said at the World Economic Forum in Davos, Switzerland, that investors want to be in companies that are doing right by society.

Moynihan’s point seemed underscored by the presence for the first time at GreenFin Summit of representatives from such mainstream investment organizations as the National Investor Relations Institute (NIRI), the Council of Institutional Investors and the National Association of Corporate Directors. According to NIRI research, the overwhelming majority of investor relations officers now think ESG issues are a pressing concern, up from less than a third 10 years ago.

Here are eight takeaways from the two-half-day event:

  • ESG analysis is a fundamental element of risk analysis. ESG factors should be integrated into 21st-century risk analysis — a core discipline, not an optional strategy — and investors cannot afford to continue treating the space as a feel-good add-on.
  • We need to expand the tent. Impact investing is still essentially a luxury product, which has to change if we hope to amass enough capital to move the needle in any meaningful way. Moreover, ESG reporting, a requirement for access to a new generation of sustainability-linked financial instruments, demands extensive internal systems that are too resource-intensive for smaller firms. The investment bankers and financial services professionals in the room recognized that part of their job is to help more companies to come onboard.
  • Business needs the help of sound public policy, but it’s not doing enough to promote it. Strong carbon pricing is urgently needed to incentivize effective climate risk management, among other things. One way to get there is for companies to increase transparency substantially around their lobbying and political spending.
  • ESG data remains muddled. There is a plethora of ESG reporting standards and divergent rating frameworks. Summit participants discussed the notion of a unified standard, without reaching a consensus on what that might be. Some investors are moving away from third-party ESG ratings, preferring to receive the underlying data and evaluate it themselves.
  • The robots are coming. The above concern may become moot as machine learning and artificial intelligence play increasingly significant roles in ESG analysis. As they do, lagging companies will have an increasingly hard time hiding their underperformance. Data — and thus real insight — into ESG performance increasingly will come not from companies’ own reporting, but from external factors and sources.
  • Companies sorely need an interdisciplinary approach. Policy makers, investors and banks came together at the summit, exactly the types of cross-functional collaborations essential to tackling urgent environmental and social challenges. At the company level, sustainability teams need to work intimately with legal and finance departments, which is a rarity today. Summit participants repeatedly emphasized the importance of proper incentives, noting that if companies embedded ESG metrics into compensation strategies, they’d see silos melt away.
  • ESG-linked financial vehicles are a rounding error in total debt markets and need to scale up quickly. With $700 billion in debt issued in the United States alone every month, the current green bond market of $250 billion is minuscule. Such vehicles need to provide a significant benefit for good ESG performance, which we’re only just starting to see.
  • The United Nations’ Sustainable Development Goals (SDGs) are investors’ North Star (or Southern Cross, depending on where you are in the world). While they were written for member states, the SDGs are eminently adaptable to business. They are the ultimate impact framework and provide a methodology that can help companies understand the part of their market capitalization that is not captured well by financial statements.

So, will the 2020s really be the decade of change in investing? According to Erika Karp, founder and CEO of Cornerstone Capital, one of the summit speakers: “Corporate sustainability is the relentless pursuit of material progress towards a more regenerative and inclusive economy.” The tools to get there already exist.

The conversation last week suggests the volition may finally be there, too.