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Covid-19 and interest in ESG
Before the pandemic hit, interest in environmental, social and governance (ESG) investing was growing in all regions of the world, and the biggest issue for many was the impact of climate change and how to address it (cf. A watershed year for ESG). After Covid-19 put the brakes on global growth, it was possible that ESG’s rising tide would ebb. Some sceptics claimed that it would be a bull market phenomenon, and unlikely to remain a priority when entire industries were struggling to stay afloat.
The truth could not be more different. Covid-19 has brought ESG issues to the fore with unexpected urgency. Chief among them has been the rise of “S”, with a much greater focus on employee welfare and the societal responsibility of businesses in a global crisis. Priorities – for corporations, households and governments – have changed dramatically.
As the pandemic swept through Europe, luxury-goods giant LVMH, for example, switched from making perfume to producing hand sanitisers,  as both use alcohol. Ford diverted airbag manufacturing capacity to making face masks  that may reduce the spread of infection. Meanwhile, in Australia, Qantas Airways leveraged its partnership with Woolworths to place furloughed workers  with the retail giant, redirecting vital labour to where it was most needed.
Sustainability outperforms during the crisis
These companies have redeployed their know-how and resources to help society, rather than to maximise short- term profit, often at their own cost. Companies that respond dynamically in this way protect their brand and business, and should have the agility to seize new growth opportunities as the pandemic is brought under control.
A growing body of evidence indicates that companies with high ESG standards are more resilient, typically have a lower cost of capital, and can offer higher quality, long- term returns. Both before and during the crisis, companies with higher ESG scores have outperformed the laggards, according to Fidelity research. The analysis used Fidelity’s own proprietary ratings rolled out over the past year to assess stock and bond performance during this short period.
During the extreme volatility in March, with net outflows across financial markets, ESG funds continued to see steady inflows. From individuals to corporations and huge asset owners, investors are increasingly favouring companies that display positive social, climate and governance attributes.
Key ESG themes for 2019
Even before the Covid-19 crisis, the role of the corporation in society was already under the spotlight, with some of the largest US business leaders stating in 2019 that its purpose had to change. Activist shareholders, environmental groups and initiatives such as the Taskforce for Climate-related Financial Disclosure had all contributed to the rising influence of ESG issues. So had the considerable business opportunities in emerging low-carbon sectors such as renewables and electric transport.
During this period, Fidelity’s sustainable investing agenda centred around five main themes: climate financing, supply chain transparency, sustainability reporting, responsible palm oil and animal protein industries. This report contains many examples of our engagements with companies in these and other important areas such as data privacy in 2019 (see Engagement section).
Our engagement activity took place around the world, encompassing many different issues, from working with famous chocolate brands on palm oil concerns to discouraging Asian banks from financing new thermal coal projects to feeding into broader country conversations about improving corporate reporting.
We believe that engagement is crucial to our role as stewards of client capital and, within that, to our active investment and ESG rating process - our Sustainable Investing team works closely with Fidelity analysts and portfolio managers when engaging with companies. It also forms part of our responsibility to run our own business in a sustainable way.
Key ESG themes for 2020 and beyond
In the wake of Covid-19, the world is a different place. While the emphasis on climate change persists in many geographies, with calls for governments to “green” the recovery, many countries and companies are understandably focused on saving lives and livelihoods. In this context, our engagement with companies becomes ever more crucial to ensuring that their business models are sustainable, in all senses of the word.
So for 2020, our climate priority will be to work with companies to disclose scope 1, 2 and 3 emissions (i.e. direct emissions from operating activities and energy use, and indirect emissions within value chains) and set measurable targets to achieve decarbonisation. As part of the Climate Action 100+ group, we will lead on some of the engagements with the world’s largest emitters, encouraging them to take necessary action on this issue.
We will also seek to engage on specific social themes such as employee welfare and to understand how companies are pivoting their business models towards greater social purpose. We have created a best practice guide for Fidelity portfolio managers and analysts to assist them when speaking to companies about how they are managing stakeholder relationships and maintaining board effectiveness, as a result of the virus.
It will be important to find ways to address inequalities that open up due to the pandemic and ensuing recession; stimulus packages typically benefit owners of financial assets, not workers. Huge income disparities inevitably lead to abrupt rather than progressive change, which can be damaging.
Following a range of successful engagements in 2019, we will continue to monitor how supply chains are changing, as we move from a pre-Covid world in which low-cost efficiency was paramount, to one in which resilience plays a bigger role. This could mean manufacturing moving closer to where customers are and paying more for labour. Lastly, as Covid-19 forces us to live more of our lives online, with more use of facial recognition and AI, we need fresh ideas on digital ethics to hold global tech giants to account.
Looking to the long term
Covid-19 and climate change are both planetary events that challenge the way we live. So far, the response to the pandemic has been largely national or regional, not global. But the economic damage has also robbed many governments of the illusion that we can go on as we are. If necessity is the mother of invention, we are confronted today with the mother of all necessities.
This presents an opportunity for companies and investors to embrace sustainable capitalism, think long-term and reset incentives for senior executives that are tied to achieving specific ESG goals. Sustainability factors are fundamentally a proxy for quality management, in my view. Corporate leadership teams that prioritise broader stakeholder outcomes are likely to be best placed to survive and thrive despite our twin health and climate crises, and offer the most stable and sustainable returns for shareholders.