In this Ropes & Gray podcast, asset management partners Melissa Bender and Isabel Dische discuss how market participants are rethinking social factors – the “S” in ESG – in light of the Covid-19 pandemic. Their conversation focuses on why asset managers may want to consider integrating social factors into their investment analysis and some challenges in doing so.
Melissa Bender: Hello, and thank you for joining us today on this Ropes & Gray podcast, the latest in our series of podcasts and webinars focused on topics of interest for asset managers and institutional investors. I’m Melissa Bender, a partner in our asset management group based in San Francisco. Joining me today is Isabel Dische, an asset management partner in our New York office and co-head of our institutional investor practice. Last time we spoke, we talked about how asset managers were reevaluating their portfolio companies due to COVID-19. Today, we’ll be continuing our discussion by examining how asset managers and others are rethinking their focus on different ESG factors due to COVID-19. Specifically, we’ll be focusing on how market participants are rethinking social factors—the “S” in ESG—and how asset managers may want to think about potential opportunities to engage with these factors in the ESG space. Isabel, would you like to start our discussion?
Isabel Dische: Thank you, Melissa. In general, a number of asset managers have noted that they’ve seen businesses which adopted the ESG principles before the pandemic outperform those that didn’t. Historically, ESG often has been viewed as a risk mitigation tool – companies that did well on ESG metrics were less likely to experience negative events. That paradigm has begun to shift. Today, asset managers are starting to think of ESG as a potential source of alpha. We’ve seen this mainly at the industry level, but certain asset managers are beginning to evaluate companies individually for ESG-related alpha.
Another interesting development is the application of ESG factors, not only to equity investments, but also to sovereign debt and corporate issues. Certain sustainability-focused asset managers have shaped their investments in particular countries based on their evaluation of the country’s rating on various ESG factors. In the bond space, market participants have seen increased demand for sustainable bond products from their investor bases. This demand seems only to have increased recently as we’ve seen ESG-focused bond portfolios outperform traditional bond portfolios during the recent economic downturn. Interestingly, asset managers may wish to think closely about how each ESG factor relates to the specific asset classes they are considering. For example, recent research has observed that strong performance in the “S” (or “Social”) factor for equities may drive performance, while strong performance in the “G” (or “Governance”) factor may drive performance for fixed income.
Melissa Bender: Thanks, Isabel. Building off what you discussed, let’s focus a little more on the “S” factor, where we’ve recently seen a significantly greater focus due to the pandemic. One thing we and others have noticed is a growing appreciation for the “Social” factor in ESG investing. In particular, asset managers may wish to think about what falls under the “S,” so to speak. The pandemic really has seemed to make asset managers take a fresh look at the “S” because high performance seems to serve as a proxy for corporate resilience. Just as an example, we’ve seen asset managers consider elements of a company’s performance that they may have discounted in the past, including various metrics related to how companies engage with employee matters. One example is measuring employee satisfaction. While not a traditional “Social” factor, evidence suggesting that companies with a more engaged workforce tend to perform better, particularly during times of crisis, has led to increasing interest in the measurement of employee satisfaction. We’ve also seen asset managers evaluate executive compensation, including whether companies are sharing the economic burdens of the recent economic downturn between management and the general workforce. Here, the thesis has been that burden sharing builds brands and generates consumer loyalty, which may generate alpha over time. In addition, whether companies have built out robust remote work systems has also been tied to the quality of their business continuity plans.
Isabel Dische: Yes. Investors are acknowledging that a company that is able to protect its workers from health risks—whether by shifting its workforce to a remote model or deploying PPE and workplace modifications—may be better able to pivot to survive the downturn. A company’s performance on social metrics also may bolster its public image. In a recent survey by Greenwich Associates, 70% of respondents expected social considerations to be important or very important going forward, an increase of 20% as compared with before the COVID-19 crisis. Notably, “social factors” can include a wide range of elements: labor standards, human capital management, gender equality and community involvement, among others. Distilled, how are companies interacting with their customers, workers and communities?
One key challenge for investors who want to incorporate some or all of these social factors into their investment programs is a lack of established or standardized metrics. The same challenges confront investors who want to incorporate environmental or governance factors into their investment programs, but social factors, in particular, are viewed by some as less measurable or having standards that vary more by region, complicating an investor’s analysis. Not too surprisingly, this heightened interest in the “S” of “ESG” has led us to ask where market participants might see expanded opportunities for ESG investing in light of COVID-19. While a variety of new ESG-aware products are coming to market, socially conscious bond issuances are of particular interest. For example, the Nordic Investment Bank recently launched a negative yield bond issuance that will be used to fund unemployment, illness, childcare and eldercare benefits needed as part of their response to COVID-19.
Melissa Bender: Clearly, this is an evolving space. Thank you, Isabel, for joining me today for this discussion, and thank you to our listeners. For more information on the topics that we discussed or other topics of interest to the asset management industry, please visit our website at www.ropesgray.com. And of course, we can help you navigate any of the topics we discussed – please don't hesitate to get in touch. You can also subscribe and listen to this series wherever you regularly listen to podcasts, including on Apple, Google and Spotify. Thanks again for listening.
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