Sense of purpose: asset owners amid COVID-19

June 2021  |  FEATURE  |  FINANCE & INVESTMENT

Financier Worldwide Magazine

June 2021 Issue

In the wake of the global pandemic, more asset owners are re-examining their purpose, mulling over how they can deliver positive social impact. Perhaps spurred on by the humanitarian crisis caused by COVID-19, many asset owners are, according to McKinsey, “using their capital, capabilities, and influence to contribute to the economic and social recovery of the communities in which they operate, so that they can deliver positive social impact beyond what they currently achieve”. For some, current conditions are feeding into a pre-existing desire to do more from a sustainability perspective.

Asset owners, such as pension funds, insurance funds and sovereign wealth funds, are committed to investing the capital they have been entrusted to preserve, and enhancing the long-term purchasing power of their beneficiaries, be they private investors or nation states. Responsible investing and a robust response to the pandemic have obvious benefits from an economic and business perspective.

Grace under pressure

Amid shifting public and regulatory expectations, asset owners are dealing with a changing operating environment that has forced them to adapt quickly to conditions caused by COVID-19. Despite the uncertainty, they need to make decisions that position them to emerge from the crisis intact, perhaps even stronger.

Some asset owners have responded better than others, with much depending on the state of their technology infrastructure and business continuity planning. Those that have pushed through the crisis are likely to have adopted, or executed, a more holistic approach to risk management.

Many asset owners continue to face their share of pandemic-related challenges. Fiscal and monetary responses to the pandemic have sent real yields on conventional fixed-income products into negative territory, which has been disastrous for the funding status of many defined-benefit pension funds, for example. Simultaneously, liability valuations have soared, while investment yields have dwindled.

“At the start of the pandemic, when supply chains and business operations were most disrupted and consumer demand changed overnight, almost all asset values declined significantly, mainly due to the significant levels of uncertainty in the markets,” says Sushil Kuner, principal associate at Gowling WLG. “While markets have recovered somewhat, the near-term outlook still remains uncertain, with many asset owners still exposed to losses in their portfolios.”

Recent market volatility may accelerate asset owners’ interest in becoming more directly involved in their portfolios as they look ahead to the next phase of the pandemic, when the global recovery begins in earnest.

The big picture

For now, as asset owners are often responsible for safeguarding national wealth and growing long-term savings, they are taking steps to respond to the crisis and alter plans accordingly. In part, this means reviewing environmental, social and governance (ESG) aspects associated with their investments.

“With the development of vaccines and light at the end of the tunnel where lockdown easing is concerned, asset owners worldwide are upping their focus on ESG and ‘impact investing’ as a result of the pandemic,” says Mr Kuner. “This, in turn, unleashes the power of capital to advance social and environmental solutions while also producing financial returns.”

New America’s Responsible Asset Allocator Initiative (RAAI) analysed how the top 25 RAAI Leaders in responsible investing have responded to the COVID-19 crisis. According to the study, 75 percent of the asset allocators analysed stressed maintaining a long-term approach to investing, sticking with ESG principles and investing in a sustainable recovery during and after the crisis. Some asset allocators doubled down on climate change action and investing, while others have invested in COVID-19 solutions and funds to support companies impacted by the crisis.

The percentage of retail and institutional investors that apply ESG principles to at least a quarter of their portfolios jumped from 48 percent in 2017 to 75 percent in 2019, according to Deloitte. Furthermore, a 2018 US Trust Wealth and Worth Survey concluded new investments in ESG funds could total $20 trillion in the next two decades.

Asset owners worldwide now routinely incorporate ESG factors into their decision making. In a decisive shift toward sustainable investing, four out of five institutions surveyed for Morgan Stanley’s Sustainable Signals survey integrate ESG considerations into the investment process. Moreover, 57 percent of firms surveyed foresee a time when they will only allocate to third-party investment managers that have a formal ESG approach. Increased constituent demand, potential financial returns, risk management concerns and heightened and evolving regulatory expectations are all driving asset owners to adopt sustainable investing – and these drivers are unlikely to fade.

ESG criteria has turned out to be incredibly valuable, with ESG portfolios frequently outperforming traditional portfolios. A review of over 200 sources on ESG performance by Oxford University and Arabesque showed that in 88 percent of companies that focused on sustainability, operational performance was improved, translating to higher cash flows.

Asset owners are drawing up success criteria over predefined time frames, considering factors such as financial as well as social, environmental, economic and technological goals. They are also considering other factors, such as demand, revenue, supply chain, staffing and so on. While these issues may require difficult investment, operational and staffing decisions, as well as discussions with investors, lenders, insurers and regulators, they will be key to shaping the future of the industry.

COVID-19 has been a wakeup call for many asset owners. The speed and scale of the global economic downturn has shone light on the need for long-term sustainability. “It is easy to see how climate change-related events, for example, may have a similar impact on the global economy,” suggests Mr Kuner. “Globally, there has been an increasing international recognition by governments, central banks and financial services regulators of the crucial role of the financial services sector in delivering global and environmental objectives and on paving the way to a greener economy.

“Market participants rely on high quality information to inform asset pricing, risk management and capital allocation,” he continues. “With an ever-increasing awareness and understanding of the impacts of climate change and other ESG issues among consumers and investors, and growing demand for sustainable investments, consumers, too, need clear disclosure from firms so that they can choose the right products.”

According to Morgan Stanley, while many asset owners are keen to report on the impact of sustainability in their portfolio investments, they often lack the tools to measure ESG performance against the goals they set. There is a need to enhance focus on ESG integration, impact investing and thematic investing. Some asset owners see a potential role for outside investment managers to advise on ESG performance in portfolio reporting, and to share expertise on approaches, issues and trends.

Given the increased focus, the ability to measure a company’s ESG performance will become more important, but it is not simple. Currently, there is a general lack of transparency around ESG issues. Not all companies are willing or able to provide the same level of disclosure regarding their policies and practices.

In addition, though there are a variety of ways to measure ESG, there is no definitive standard for doing so. Several institutions, investors and third-party agencies have developed their own methods, while a number of ESG rating agencies have emerged to provide assessments of companies globally, allowing asset owners to identify and understand financially material ESG risks to a business. As an example, the Global Reporting Initiative (GRI), as an international independent standards organisation, has developed a methodology that aims to help standardise how businesses report on their ESG-related policies.

Elsewhere, the UN’s Sustainable Development Goals (SDGs), composed of 17 goals, 169 targets and 232 indicators, are a valuable resource. Several of the 17 goals can be directly tied to a company’s operations. Decent work and economic growth, clean water and sanitation, sustainable cities and communities, responsible consumption and production, and climate action are some of the goals businesses can work toward. The measures a company has, or has not, put in place to achieve these goals can be evaluated to determine its ESG impact and performance. The six Principles for Responsible Investment and the Equator Principles are additional sources that can be used to create questionnaires and evaluation criteria.

While these efforts may boost the availability of useful information, there is no legal requirement for companies to report or disclose their ESG performance. Yet a company’s ESG score, and its ability to improve that score over time, may become a vital part of attracting investment in the future. ESG ratings also provide a valuable internal benchmarking tool which can guide decision making and boost sustainability.

Regulatory imperatives

According to Mr Kuner, adopting ESG factors is a shrewd move by asset owners, given that regulators worldwide are starting to introduce new ESG-related disclosure rules for the financial services sector. This includes disclosure as to whether, and the extent to which, asset managers and asset owners are considering principal adverse impacts on sustainability factors. “Asset managers or asset owners that do not take these into account, or are perceived as not doing enough to ensure the long-term sustainability of their investment decisions, risk reputational damage,” warns Mr Kuner.

The UK Stewardship Code, which is administered jointly by the Financial Reporting Council (FRC) and the Financial Conduct Authority (FCA), seeks to guarantee the responsible allocation, management and oversight of capital to create long-term value benefitting the economy, the environment and society. The Code has substantially raised the bar in terms of what is expected of asset owners. It introduced a suite of new requirements, including greater monitoring of their asset managers’ investment strategies and stewardship activities.

In France, Article 173 of the energy transition law requires investors to explain how they incorporate ESG factors into their investment strategies. This development has no doubt helped investors shift toward managing their assets with ESG criteria in mind.

The economic pressures exerted by the pandemic have served to heighten the importance of stewardship engagement around several other key areas, such as climate change, economic recovery and diversity. These developments have required asset owners to shape their strategies to meet the evolving values and priorities of the stakeholders they represent.

Focus

With the rollout of mass vaccinations, there is hope that the pandemic may finally be drawing to a close. The last 18 months have demonstrated the importance of robust risk management strategies and a renewed focus on strategic asset management. In the face of significant disruption, asset owners have been re-examining their purpose. As the ‘new normal’ emerges, a renewed focus on sustainability may give asset owners the purpose they require, and stakeholders demand.

© Financier Worldwide

BY

Richard Summerfield