Sustainable and Impact Investing in the New World
By George R. Gay | Download the PDF
Many pundits discuss the “New Normal” that will arise when the pandemic ends and the economy recovers. For many in the U.S. and for most in the developing world, the “Old Normal” was not that great. The “Next Normal” will need to provide more equitable and more sustainable living conditions for a much larger portion of the population.
As I near the end of my 33rd year at First Affirmative Financial Network, I reflect on what I have experienced in, and hopefully have learned from, the financial marketplace. The “Crash of 1987.” The “Asian Contagion.” September 11, 2001. The “Dot-Com Bubble and Burst.” “The Great Recession.” “The Flash Crash.” Except for 9-11, these market experiences were all the result of government, economic, or market decisions or conditions, frequently combined with some type of “financial engineering.”
These are the words we are never supposed to say: “This time it’s different.” The 2020 triple whammy of COVID pandemic, social unrest, and the growing menace of Climate Change will change many aspects of the investment landscape and economic behavior, in some cases for a temporary timeframe, and in some cases almost certainly permanently.
At the time that the long-term health of our economy is compromised by Environmental, Social and Governance risks, the use of ESG research to evaluate investments based on these very factors has moved to the forefront of the investment conversation. The Sustainable, Responsible Impact Investing community, with leadership from First Affirmative and our annual industry event, the SRI Conference, were pioneers of the concept that corporate decisions relating to race, gender, product safety, environmental stewardship, resource conservation, and other values-related areas are strong determinants of investment performance and risk, as well as economic and societal well-being. Indeed, it is ironic that our previously scorned point of view is now being embraced, via the new ESG language, by almost every part of the investment industry.
Even more importantly, the current market has provided abundant evidence that utilizing ESG research can work to improve performance and reduce risk. While past performance cannot guarantee future results, we are confident that business models of responsible companies are often based on a more solid foundation which also reflects better valuations.
A quick look at the landscape. The 10-year Treasury Bond yields 0.71%, not far from its historic low. The 30-year Treasury Bond yields 1.45%, less than the dividend yield on the S&P 500 of 1.96%. A substantial amount of international debt is priced to yield less than zero. By most valuation metrics, the stock market is richly valued, as the economy slides into a recession plagued by historic unemployment rates, with recovery dependent on a yet unfound vaccine.
The impact of the pandemic and social justice concerns is moving so fast that it is impossible for ESG researchers to keep up. The expectations for an acceptable level of gender and racial diversity in corporate management and C-Suites will have to change radically. The view of the sustainability of certain economic sectors will also have to be totally reconsidered. For example:
- Real Estate. Shopping malls and big box stores were already dying due to the Internet. Add to that the question of whether half of employees will ever return to office cubicles in high-rise buildings in downtown locations. How will downtown businesses like restaurants and stores survive if people don’t return downtown to work? As people have lost their jobs, they have stopped paying their mortgages or their rent. Once eviction protections expire, the homeless population is expected to increase dramatically.
- Mortgage processing. These firms collect mortgage payments and then break them into constituent parts, forwarding payments to investors, governments and insurance companies. When people stop paying mortgages, these payments must still be made.
Investments rise and fall based on the present value of expected future profits. Investment managers will have to be flexible and willing to change old ways of evaluating businesses and markets. Asked what his customers most wanted, Henry Ford is alleged to have said “faster horses.” The Industrial Revolution took a century. The Digital Revolution has taken about 25 years. The COVID Revolution is taking only months. Evaluations of risks need to consider the short-term dislocations caused by current conditions and the longer-term trends related to climate change.
Investors have historically relied upon asset allocation, the relation between equities, debt and cash, to manage risk. Under many circumstances, different types of investments move differently from one another. Occasionally, as in March of this year, they all move in the same direction at the same time. In the future, it will matter more than ever before, WHICH industries are included in an investment universe and which will be omitted. Expected investment outcomes must be based on our current starting point, and not on historic outcomes.
As we look to the future of investment, people who understand ESG metrics will have a good start, but people who can distinguish right from wrong, and fairness from inequity, will be those who can truly provide leadership not just in investments, but in society at large.
George R. Gay CFP® AIF®
Chief Executive Officer