COVID-19 Has Highlighted the “S” in ESG

Q2 | May 2020

Topic: Investments

John C.A. Stevenson CFA

May 29, 2020

Image used with permission: iStock/cnythzl


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COVID-19 Has Highlighted the “S” in ESG

Q2 | May 2020

“ESG” has become a powerful three-letter “word” in the investment world in recent years. The letters stand for three criteria on which any company can be evaluated: environmental compliance and stewardship, social responsibility, and corporate governance.

These criteria are quickly becoming important lenses through which investment decision making occurs, both because failure to act responsibly in any of these areas can present real financial risk, but also because excelling in these areas can positively differentiate a company from its peers.

In the “old days”, socially responsible investing usually involved negative screens. Don’t buy tobacco or alcohol stocks. Don’t buy gambling stocks. Don’t buy the stocks of companies that make land mines that can kill unsuspecting children playing in a field. In my university days, I can vividly remember the protests to demand that Harvard divest from companies in South Africa during the Apartheid era. These are all rules that reduce the opportunity set for investors. Of course, whenever the opportunity set is reduced, there is a cost of lower expected returns. The challenge was that the cost was unquantifiable and the rules themselves often hard to define.

Today, the emphasis in the investing world has shifted such that many investors, Nexus included, consider ESG factors in a positive way. Companies that are leaders in these areas often are more successful than their peers. Strong ESG performance, theoretically, can lead to higher investment returns, not lower returns, which is the theoretical consequence of negative screens.

Many investment firms integrate ESG analysis into their investment process. ESG evaluation becomes one of the criteria, along with competitive analysis, valuation analysis, management interviews, etc. Importantly, ESG integration does not preclude any investment the way a negative screen does. It simply tries to ensure that all the investment risks are fully considered. An energy company, by definition, faces significant environmental risks. It’s the nature of its business that it cannot avoid. But some companies will manage this risk better than others. ESG integration supports investment in such a company, but only after an investor is satisfied the company is managing the risks effectively.

Nexus’s investment process integrates ESG factors just as described above. We subscribe to ESG analysis from an organization called Sustainalytics, which is one of the two big ESG research providers in North America. Sustainalytics has 250 analysts covering 11,000 companies around the world. We have found its research to be extremely useful as it provides a different perspective on companies than traditional investment research. Having said that, ESG has always been part of the Nexus investment process, we just didn’t use the current vocabulary. If you are serious about making long-term investments, it matters that a company operates in a sustainable way. Today’s ESG considerations provide a more detailed and comprehensive template for analysis. It is an evolution rather than a revolution.

This somewhat drawn out background brings me to the title of this essay. COVID-19 has affected how investors think about ESG. Before the pandemic, there is no doubt environmental issues were consuming the vast majority of attention related to ESG. You can’t pick up a newspaper without reading, usually on the front page, an article about climate change and how companies and governments are addressing it… or not. There always has been a focus on corporate governance. It matters that boards are independent, and it matters that shareholders voices are heard. We have occasionally voted our proxies against management and in favour of greater shareholder democracy where it seemed appropriate. Until recently, however, the “S” in ESG was often given short shrift. COVID-19, however, has provided social considerations their moment in the sun.

The “social responsibility” element of ESG considers how a company treats its various stakeholders, such as employees, suppliers, customers, and local communities. Considerations like diversity, human rights and consumer protection are at the centre of it. Using child labour to manufacture products in a sweat shop is a situation that would be deeply disturbing. But social responsibility also addresses the general question: is a company being a good corporate citizen? These issues are critically important but have been over-shadowed in recent years by the climate change discussion. Never have investors been more interested in how a company is treating its employees, customers and suppliers as during this health crisis. Moreover, we think that the reputation companies build in the crisis could well become a competitive advantage that is enduring.

George Weston is the most recent stock we have added to our investment portfolios. Within George Weston, the biggest business is Loblaw. The accelerated roll-out of its “PC Express” service, which facilitates customers’ contact-less click-and-collect grocery purchases, has established Loblaw as the leader in online grocery in Canada. Moreover, Loblaw chose to waive the fee it normally charges for the service to help families in this difficult time. It has also made substantial efforts to ensure the safety of its essential frontline employees. We think Loblaw will benefit greatly from customer loyalty and its first mover advantage long after the health risk has subsided.

Similarly, another Nexus holding, TELUS, has announced it will voluntarily extend payment terms for customers in financial distress, put a moratorium on disconnections while the crisis persists, waive any data overage charges for internet customers working from home, and waive roaming charges for a large segment of its customer base. These are all measures which help TELUS’s customers today. However, we think TELUS will be well-rewarded over time with the economic benefits that come from increased customer loyalty.

Quite frankly, we have always thought that the “social” aspect of ESG didn’t get as much attention as it deserves. While we certainly wish that COVID-19 never existed, a greater focus on corporate social responsibility is a positive by-product of this crisis that we hope becomes permanent.

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