COVID-19: Implications for ESG Investing

By Guillaume Mascotto - April 2020

There’s no doubt COVID-19 is altering global societies and economies. Yet the virus is affecting investment theory, too. There is a growing consensus among many investors that the so-called neoclassical economic theory must evolve past the sole focus of maximizing firm profits.

These investors assume what is good for the long-term viability of our economic system and society will also lead to good stocks and good companies. As a result, investors are increasingly measuring company performance by more than just financial profit and loss. While key trends were already altering the investment management landscape prior to COVID-19, we believe the virus’ escalation to a global pandemic will hasten the shift in mindset toward sustainable investing. This shift does not seek to splinter socio-economic development. Instead, it seeks to  achieve a balance between environmental, social and economic considerations.1

Systemic Risk vs. Idiosyncratic Risk

Public health is a key ESG issue, but it’s important to distinguish between systemic risk and idiosyncratic risk. Negative public health externalities are only the results of idiosyncratic risk if company misconduct or process quality/asset integrity failures trigger the issue.

In the case of COVID-19, there’s currently no evidence establishing a direct link between the pandemic’s cause and companies’ ESG risk management practices. Nevertheless, the pandemic’s reverberations will undoubtedly impact those risk management fundamentals in the future.

Three Major ESG Implications of COVID-19

Against this backdrop, we have identified three major ESG implications of COVID-19:

1. The “S” pillar of ESG will gain traction.

We believe the pandemic’s tangible consequences will result in growing investor focus on companies’ social performance. We expect investors to consider more qualitative indicators as a gauge of long-term competitiveness (human capital) and operational integrity (business continuity). These indicators include:

  • emergency response mechanisms (e.g., telecommuting, distributed management)
  • supply chain controls (e.g., quality and safety management, local vs. global dependence)
  • employee benefits (e.g., paid sick leave, health and well-being programs, short-time work, telemedicine)

As companies adapt to the “work-from-home era,” they also face heightened data privacy and security risks. This makes managing cybersecurity risk incredibly important. Best practice cybersecurity programs include:

  • General Data Protection Regulation (EU GDPR) compliance
  • best-in-class certifications (e.g., ISO 27001-2, ISO 27018, SOC, PCI, FISMA)
  • dedicated, quarantined IT security staff

2. Investors will increasingly seek active ESG solutions.

We believe integrating material ESG factors within fundamental research can help minimize downside risk or capture upside potential not otherwise captured by traditional financial analysis. The pandemic-led volatility underscores the importance of active ESG solutions when navigating market cycles.

Our underlying investment philosophy assumes high-quality issuers with strong fundamentals will outperform over time if they also have:

  • long-term competitive advantages
  • strong ESG risk management practices
  • solid margins of safety against short-term adverse systemic forces—including rising costs related to COVID-19

We dub this an “ESG Active Barbell” approach. 

3. Nature, health and finance will become intertwined.

Some observers think the COVID-19 pandemic detracts from the fight against climate change. They fear public and private investment in renewable energy will decline due to lower near-term profits and potential capital reallocation toward social-related risk management priorities.2

In reality, the drastic mitigation measures put in place to fight the virus may be helping clear the air, too. Geospatial data from the European Space Agency’s Sentinel-5P satellite and NASA show a 40% reduction in nitrogen dioxide (NO2) levels over Italy. Similarly, NO2 levels over eastern and central China have fallen 10%-30%.3 Just as mitigation measures are likely to remain in place in the near term, their positive effects on the environment and public health are also likely to persist.

While weather conditions could skew data of satellite observations, asset owners focused on decarbonizing their portfolios may take the opportunity to redouble their efforts—arguing that urgently transitioning toward a lower-carbon economy is, in fact, doable. The association between particulate matter ambient air pollution and serious health implications is well documented. A 2019 study in The New England Journal of Medicine, for example, concluded that short-term exposure to certain types of particulate matter in 652 cities worldwide was independently associated with daily all-cause, cardiovascular and respiratory mortality.4  

It is possible the drop in air pollution may be offset as global industries ramp up again to make up for economic losses once the virus is contained. In this context,  investors are likely to favor companies that go beyond regulatory compliance and embrace the right long-term strategic direction. In addition to strong social-related risk management programs, this strategic direction could include investment in renewable energy or negative emissions technologies, board-level oversight on environmental performance and executive long-term incentive targets aligned with the International Energy Agency’s 1.5°C Sustainable Development Scenario.

Moving Toward a Circular Economy Mindset

The COVID-19 pandemic and its material human, economic and financial costs could very well support the notion that the environment, public health and the global economy intertwine. As such, we believe investors are likely to look for ways to align their investments with the long-term safeguarding of the planet and people’s lives without sacrificing returns.

Discover More:

Our ESG Approach

1 David Gould, “The ESG Equilibrium,” Institutional Investor, August 5, 2018, https://www.institutionalinvestor.com/article/b18q7znkjy40l6/the-esg-equilibrium 

2 Bloomberg New Energy Finance recently cut its 2020 global solar growth forecast from 121-152 GW to 108-143 GW. See“BNEF Predicts slow-down in clean energy economy due to Covid-19,” Power Engineering International, March 13, 2020, https://www.powerengineeringint.com/renewables/bnef-predicts-slow-down-in-clean-energy-economy-due-to-covid-19/  

3 While not a greenhouse gas, NO2 is a pollutant resulting from the same activities and industrial sectors that drive global warming and are responsible for a large share of the world’s carbon emissions. See Jonathan Watts and Niko Kommenda, “Coronavirus pandemic leading to huge drop in air pollution,” The Guardian, March 23, 2020, https://www.theguardian.com/environment/2020/mar/23/coronavirus-pandemic-leading-to-huge-drop-in-air-pollution 

4 Cong Liu, M.S., Renjie Chen, Ph.D., and Franceso Sera, Ph.D., et al., “Ambient Particulate Air Pollution and Daily Mortality in 652 Cities,” New England Journal of Medicine 381, no. 8 (August 22, 2019): 705715. https://www.nejm.org/doi/full/10.1056/NEJMoa1817364 

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      A strategy or emphasis on environmental, social and governance factors ("ESG") may limit the investment opportunities available to a portfolio. Therefore, the portfolio may underperform or perform differently than other portfolios that do not have an ESG investment focus. A portfolio's ESG investment focus may also result in the portfolio investing in securities or industry sectors that perform differently or maintain a different risk profile than the market generally or compared to underlying holdings that are not screened for ESG standards.

      Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.

      The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.