This article is part of NordSIP Insights – Impact Investing Handbook. Read or Download the entire publication here.
by Guillaume Mascotto, Head of ESG and Investment Stewardship, American Century Investments
It is clear COVID-19 has altered global economies, but it has also affected investment theory. Investors assume what is good for the long-term viability of our economic system and society will also lead to positive investment outcomes. It’s no longer about what makes a good stock, but what makes a good company.
The virus’s escalation to a global pandemic has hastened the shift in mindset toward sustainable investing. While public health is a key ESG issue, the effects of COVID-19 are being felt in areas beyond individuals’ health and well-being. We believe investors will increasingly focus on the Social (or “S”) pillar of ESG in the aftermath of the global pandemic. Investors will also measure the impact of an effective and transparent diversity, equity and inclusion (DE&I) strategy, business ethics and strong corporate governance on company performance.
The “S” Pillar Will Gain Traction
While social issues have always been central to ESG analysis, especially for exposed sectors such as health care, technology and consumer, one of the pandemic’s tangible consequences is the elevation of the social dimension of ESG.
For ESG analysts to consider public health negative externalities idiosyncratic, they would need to determine if the issue is triggered by misconduct or failure of companies’ process quality or asset integrity (i.e., “ESG fundamentals”). In the case of COVID19, available evidence does not establish a link between the cause of the pandemic and companies’ ESG risk management practices (as was the case in 2008).
However, the pandemic’s societal reverberations are having an impact on these ESG fundamentals, especially under the social pillar. Institutional investors are likely to increase focus on companies’ emergency response mechanisms (e.g., telecommuting and distributed management) and employee benefits (e.g., paid sick leave and telemedicine) as a gauge of long-term competitiveness (human capital) and operational integrity (business continuity). While companies could adapt to the “working from home” era, they will also likely face heightened data privacy and security risk.
Pre-pandemic, these factors were difficult to quantify. Investors now understand they can have material implications for the companies they invest in and therefore need to be quantified and accounted for. Subsequently, and considering the growing issue of “green washing,” the post-COVID-19 investment space is likely to result in increased investor ESG due diligence. Investors will likely ask for verifiable evidence that ESG considerations, including those flowing from COVID-19, are formally integrated into a manager’s investment process and for support of such claims by stock selection, reporting and portfolio construction.
DE&I and the effect on the Bottom Line
From an investment perspective, research increasingly shows the financial benefits to companies that emphasize DE&I in their organizational and business strategies. For example, the Pipeline’s “Women Count 2020” report found FTSE 350 companies with executive committees comprised of at least 33% women had a net profit margin over 10 times greater than companies with no women on their committees.
Investors place growing importance on this topic and are the main drivers of momentum in the ESG space. DE&I is also playing a larger role in manager selection as asset owners and large investment consultants include more questions and criteria during the due diligence process. A survey by the CFA Institute found that 83% of institutional investors value gender diversity specifically, with 55% believing that it drives better performance in investment teams. Even so, governments are passing new regulations to establish quotas for female participation and revamping older regulations with stricter requirements. Examples include Germany , France and California (the first and only U.S. legislation).
We believe companies lacking transparency in this area or trailing their peers’ DE&I efforts may see negative impacts to their long-term competitiveness, brand reputation or financial condition.
Governance as Part of DE&I Analysis
When evaluating companies for our portfolios, we use a proprietary framework to assess each company’s risks related to environmental, social and governance (ESG) issues. Within this framework, we consider DE&I to be sector agnostic and include it under both the Social and Governance pillars of the ESG equation. We specifically look for strong evidence of DE&I as part of a company’s human capital strategy. We believe DE&I to be a material factor for workforce acquisition, and by extension, long-term competitiveness. Gender diversity in the boardroom and in senior and middle management is another of the factors to consider when analyzing a company’s Governance practices. We immediately flag companies with no women on their boards of directors. We also use the Hampton-Alexander Review’s annual “FTSE Women Leaders” report to help evaluate corporate board membership. As part of our proxy voting guidelines, we also support resolutions pertaining to DE&I, including gender and racial pay gap and board parity.
A strategy or emphasis on environmental, social and gover¬nance factors (ESG) may limit the investment opportunities available to a portfolio. Therefore, the portfolio may underper¬form 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.
The opinions expressed are those of the portfolio team and are no guarantee of the future performance of any American Cen-tury Investments portfolio. This information is for an educational purpose only and is not intended to serve as investment advice. References to specific securities are for illustrative purposes only and are not intended as recommendations to purchase or sell securities. Opinions and estimates offered constitute our judgment and, along with other portfolio data, are subject to change without notice.
This information is not intended as a personalized recommen¬dation or fiduciary advice and should not be relied upon for investment, accounting, legal or tax advice. No offer of any security is made hereby. This material is provided for informa¬tional purposes only and does not constitute a recommenda¬tion of any investment strategy or product described herein. This material is directed to professional/institutional clients only and should not be relied upon by retail investors or the public. The content of this document has not been reviewed by any regulatory authority.
American Century Investment Management (UK) Limited is authorised and regulated by the Financial Conduct Authority. American Century Investment Management (UK) Limited is registered in England and Wales. Registered number: 06520426. Registered office: 12 Henrietta Street, 4th Floor, London, WC2E 8LH.
©2020 American Century Proprietary Holdings, Inc. All rights reserved.