Covid crisis insight: “Broad changes in sustainability”

Throughout the covid-19 crisis, Funds Europe presents some of the best market commentary from fund professionals. Today, we ask Lombard Odier Investment Managers’ Kristina Church, senior investment strategist for sustainability, and colleague Christopher Kaminker PhD, head of sustainable investment research, strategy and stewardship, to analyse the new normal and what the lasting effects of this pandemic could be.

Is a return to “business as usual” at a global/financial scale viable, and is it something asset managers should be vying for?

It is vitally important from an economic standpoint to see a return to productivity at a global scale as quickly as is safely possible. But the degree to which this is a return to “business as usual”, as opposed to an entirely new way of functioning is still debatable. We hope many of the more sustainable work habits formed as a result of physical distancing will remain even once lockdowns ease. We also believe that the covid-19 pandemic has highlighted the importance of building sustainability into active management of asset portfolios, in order to identify the businesses likely to offer upside to future sustainability challenges and to avoid those encompassing the greatest risks.

The pandemic is likely to act as a catalyst, accelerating existing trends in e-commerce, logistics and cyber security, as well as underlining the fragility of others.

We certainly expect to see a prolonged shift in supply chains as businesses find new, closer-to-home solutions for critical material sourcing. An example may be low value-added chemical components, suddenly deemed essential because they are the raw ingredients of basic off-patent drugs. We may see the same trend in food sourcing as we adjust to changing supply levels and face up to the fragility of our existing supply networks. 

The automation of industrial processes, warehousing and solving logistics bottlenecks will all undoubtedly accelerate to cope with the new urgencies and are likely to remain a priority for businesses long after the pandemic. 

From a climate science point of view, the current crisis is going to offer researchers an unparalleled opportunity to study the impact of human behaviour on the environment. There is a chance to learn what happens to greenhouse gases in the atmosphere when the world returns to 1950’s levels of international transportation. Will commitments to reduce greenhouse gases be weakened, faced with slowing economies? Or will the experience of lower levels of pollution, including in the emerging world, and an understanding of the positive economic growth impacts of investing in green infrastructure spur more action? 

As residents of many cities have been enjoying cleaner air under lockdowns, public tolerance for a return to business-as-usual is likely to be diminished, along with increased recognition of the impact of air pollution on public health. Research is now linking exposure to pollution with the spread and mortality rate of Covid-19, through the effect of air pollution on the body’s immune response and on underlying, aggravating health conditions. A review of the causes and contributing factors of the crisis may reinvigorate efforts to tighten emission controls, especially in transport.

Travel is an obvious short-term casualty and raises questions about how quickly it will recover once movement restrictions begin to lift. There was already a strong regulatory drive to improve the sustainability of transport prior to the current crisis, but the impact on congestion from lockdowns and the resultant improvement in air quality may stimulate greater regulatory action. We are already seeing many international cities implementing restrictions on combustion engine vehicles and increasingly proposing outright bans on all cars in city centres over the next two decades. The current crisis has highlighted the importance of efficient public transport systems but also the need to ensure the smooth transport of vital goods. We expect to see an increased regulatory focus on harder-to-abate, freight and long-distance transportation, as well as the potential for a shift in consumer sentiment towards more sustainable modes of travel.

We may see more corporate travel restrictions and a prolonged impact on leisure travel, in particular long-distance travel. That is likely to combine with travellers’ growing environmental sensitivities, and may generate some shift from air to rail travel. In the short run, any lasting change in business and leisure travellers’ behaviour may prolong the pressure on oil prices, despite the recent OPEC/Russia deal, depressing oil prices still further since aviation fuel accounts for 7% of global demand. 

Overall, we believe asset managers should be embracing the changes in patterns of economic growth as a result of the crisis. We expect to see an acceleration in leaner, more efficient and circular manufacturing and supply chains and that many businesses will benefit from enhanced capabilities due to growing connectivity and digitalisation. Many of these changes were already underway prior to covid-19 but the crisis has brought the need to focus on adaptation and resilience even more to the forefront for successful asset management.

Is now a time to put ESG on the agenda more-so than before, or should firms be focusing on surviving?

It is clear that the ovid-19 crisis has already had a devastating impact on global society and economies and will continue to do so in the months ahead. Will world leaders still see climate change as a priority with their economies in recession or recovering? The United Nations’ climate change conference, scheduled for November, has been postponed to 2021 and international first responses to the crisis largely ignored green financing criteria within emergency bailout packages. 

However, this does not mean we believe sustainability has moved off political agendas. We expect the next round of fiscal stimulus packages to provide a boost to green infrastructure. In the EU, at least, it appears likely that any long-term support programmes will be aligned to the EU’s Green Deal announced last year. The most powerful leaders in the EU are hammering home that the EU Green Deal must be central to a resilient recovery and most of the key elements are still on track, including the sustainable finance and circular economy action plans. Industry and finance is also largely backing this policy objective, even if some of the climate related targets are delayed, the investment and stimulus aspects look set to continue. 

Similarly, South Korea has announced it will implement a Green New Deal with a 2050 net-zero emissions goal and the end to coal financing, after the Democratic Party’s landslide victory in one of the world’s first elections post covid-19.

Elsewhere, an increase in the availability of low-cost loans and capital will make investments in energy efficiency and renewable technologies more attractive, both of which require an upfront capital outlay but offer a positive economic return. 

Sustainability is on the agenda for corporates too. Net-zero commitments by corporates have almost doubled year-on-year, with up to 100 made in the first quarter this year compared to 53 in 2019 during the same period.  Royal Dutch Shell Plc* recently announced its plans to become a net-zero emissions company by 2050, including full scope 3. This is a more ambitious target than that of Eni which aims to reduce greenhouse gas emissions by 80% by 2050 in absolute terms. It is also broader in scope than that of BP and Repsol, which have a net zero carbon target by 2050 that applies only to the life cycle of all barrels they produce.

Today, studies show more than $30 trillion of global assets are already invested in a manner that integrates some form of sustainability or ESG. But post Covid-19, we believe the sustainability of numerous businesses will be scrutinised in new ways, and offer opportunities for the most nimble standouts, including tech sector firms. It is vital not to focus on just integrating sustainability into the security selection process but instead to place sustainability at the very core of the strategy.  

We see the corporate world bifurcating into two types of companies – which we refer to as the Eagles and the Ostriches. Eagles will have the foresight and agility to adjust their business models to maintain long-term sustainable profits. They will focus on multiple bottom lines – not just profits but also people and the planet. We do not believe it is possible to identify these companies solely based on static ESG metrics or a strategy that merely integrates sustainability into the security selection process.   We believe it is important to identify transitioning businesses and solutions companies that are reacting to the shifting environment and that this can only be achieved by placing sustainability at the core of our strategies.

This pandemic has caused a lot of heartache and hardship for many people. Looking forward, what positives would you like to see coming out the other side of the coronavirus crisis?

We hope the current crisis will drive more investors to align with a core conviction approach to sustainability. It is only by incorporating rigorous, forward-looking, judgmental analysis about each company that investors can build a true picture of the sustainability of their portfolio. During this current period of uncertainly, identifying those businesses best positioned to adapt to crises and avoiding those oblivious to the need to react and transition to more sustainable business models is even more vital. At Lombard Odier we are constantly looking to identify companies that have expanded their focus to multiple bottom-lines – not just profits, but also people and the planet. In this environment, we strongly believe the most sustainable companies are going to outperform the market and generate strong investment returns for our clients.

The analysis differs little when trying to identify and invest in those companies able to thrive and adapt to a carbon-damaged world, as those able to weather a pandemic, or any other sustainability challenge. We believe the coronavirus pandemic will focus investors in the near-term on selecting securities with the most sustainable financial models and those businesses that can continue to function in a revenue constrained-world. 

To date, only a small part of the investment community has begun investing in sustainability as a core conviction. There is still a dearth of quality data coupled with a lack of clear definitions and standards around the integration of ESG or sustainability into portfolios. Carbon footprinting as practised in the market is incomplete and largely fails to cover the full scope of carbon emissions associated with a company’s business (disclosure of scope 3 emissions is patchy, at best). It routinely ignores the positive benefits such as avoidance or reduction of carbon emissions associated with a company’s business model. 

It will only be through thorough, judgmental and forward-looking analysis of how business models are exposed to key sustainability challenges, such as pandemics and resultant supply-chain shortages, that investors can hope to protect their portfolios from future challenges. These challenges may come in the shape of the need to protect portfolios for risk and return in the face of climate-damage, political unrest, changing global trends in consumption and demand, or the digital revolution, but it is now, more than ever, important to analyse these challenges. 

In recent years, a number of cleantech and low-carbon funds have emerged that invest in poster-child technologies such as renewable energy and electric vehicles, or in low-impact sectors. Few of these funds, however, encapsulate the full extent of the transition required across all sectors, especially the carbon-intensive industries, such as steel, cement, and chemicals. 

We recognise that the future economy will still require the harder-to-abate, carbon-intensive industries – but that they will have to transform and transition. We will still need steel and cement to build infrastructure to protect cities from greater climate damage, or to develop urban areas to accommodate the rising urban population. Indeed, addressing climate change requires that we continue to invest in these industries so that they are able to invest in their own transformation to lower carbon-intensity. 

Can there be a return to “normality” following this pandemic, or is now a time to change the status quo?

As the impact of covid-19 unfolds, longer-term changes in consumer behaviour and impacts on sectors from tourism to technology are attracting critical attention. Many attempts at projecting the longer-term impacts of the current coronavirus pandemic depend on the extent to which changes in consumer behaviour patterns turn out to be permanent once the lockdowns start to lift. 

How long does it take to form habits that stick? The consensus, according to research from psychology, is that it takes around two months for a habit to form.  Historically, crises have led to dramatic social change. After the twentieth century’s World Wars, universal health services were put in place (though not by the US), women earned the right to vote in many democracies and joined the workforce in large numbers. After the terrorist attacks of 2001, we adjusted to airport security restrictions and the financial crisis of 2008 exacerbated inequalities, triggering a widespread rise in political nationalism and xenophobia. 

This time, we can envision broad changes in sustainability, connectivity technologies, globalization and geopolitics. 

We expect governments to use the crisis as an impetus for more targeted regulation on both environmental and social factors. With consumer pressure and technological innovation also spurring change. These powerful market forces, combined with the increasing outperformance of businesses with the most results-focused ESG metrics, will drive a greater investment focus on sustainability.

The acceleration in climate-related action from both regulators and consumers is already driving increased opportunities for those companies positioned to thrive in a carbon-constrained world. At the same time, we recognize that no matter how accelerated this action becomes, climate damage of some degree will undoubtedly occur globally. In our view, this offers opportunities for those companies positioned to increase climate-resilience through strengthening infrastructure, monitor risks through meteorological tools, and managing impact through re-insurance activities. It is important to focus on these adaptation companies as much as low-carbon solution providers. 

© 2020 funds europe

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