The crisis has highlighted the imperative to create an improved, more resilient local, and global, economy that is better able to cope with any future catastrophes. Efforts to address the immense social and environmental challenges we currently face will be of prime importance in both the public and private sector.
How might we use this current crisis to catalyse collective action to build more resilient economies and how is the role of responsible investors being reshaped and redefined for an after-coronavirus (AC) world? Tarryn Sankar, Head of Listed Credit, shares her thoughts on how COVID-19 might be used as an opportunity to build economic and environmental resilience.
Crises don’t create, they reveal
While the exact origin of the COVID-19 virus is yet to be scientifically established, the World Economic Forum estimates that 60% of infectious diseases originate from animals, and 70% of emerging infectious diseases originate from wildlife. According to Standard Bank Securities, scientists have found that between two and four new viruses emerge annually as a result of human infringement on the natural world and the vast illegal wildlife trade.
Pandemics are, therefore, often a hidden side effect of economic development and inequalities that can no longer be ignored, shining a bright light on the devastating ripple effects triggered when one element in an interconnected system is destabilised. Just as carbon is not the cause of climate change, it is often human activity – rather than nature – that causes pandemics.
The spread of the coronavirus pandemic has further driven home the global interconnectedness of all stakeholders. These parties now have to collectively grapple with the real-time implications of how non-financial risks (in this instance, a global public health crisis caused by COVID-19) translate into significant financial risks.
Although the current crisis has its roots predominantly in a health emergency, it highlights the extent of damage a non-financial disaster can inflict on the world and the crucial interdependence between businesses and their environmental, social and governance contexts. It has also highlighted how the health of the society on which companies depend for their financial sustainability, relies on the existence of adequate social welfare systems and the absence of extreme poverty and inequality.
Even if we find a vaccine for this novel coronavirus within the next 18 to 24 months the potential for further severe outbreaks is likely to remain significant, thanks to the combination of our interconnected world, air travel, illegal wildlife trading and climate change. The only solution is that we use this opportunity to build systems better able to avert or absorb future shocks.
The interconnectedness of climate change and virus pandemics
The recent collective experience, whether in the public or the private sector, has more often been shaped by financial shocks rather than physical shocks. One of the most notable aspects of the current COVID-19 pandemic is that it shows just how far-reaching and cataclysmic a physical shock of this magnitude can be – and what we can potentially expect from future crises.
While the global financial crisis in 2008 was a financial upheaval of significant proportions, its economic and social impacts were ultimately narrower and, with the benefit of hindsight, relatively short-lived compared to the expected economic impact of this novel coronavirus.
Global financial markets went on to win back much of their initial losses over the following decade, leading to their longest bull run in history. The 11-year rally only came to an abrupt end when COVID-19 began to spread uncontrollably into the Western world in March this year, with the S&P 500 dropping by 26.9% in a mere 17 days. This compares starkly to the 39 days it took in 1987 for the S&P 500 to lose roughly a third of its value in the wake of Black Monday.
One of the defining features of physical shocks, as compared to financial shocks, is that they can only be remedied by understanding and addressing the underlying physical causes. The Venn diagram below shows the differences and similarities between climate change and virus pandemics.
Climate change and virus pandemics share several defining features with regards to their impact, including their ability to rapidly and exponentially impact societies with a particular focus on their most vulnerable elements. Climate change can act as a potent risk multiplier for virus pandemics, with a 2003 study finding that the death rate for SARS (Sudden Acute Respiratory Syndrome) was twice as high for those living in cities with high air pollution.
Unfortunately, one of the critical differences between climate change and virus pandemics is that the former affects different regions in different ways and at different times. There has been much criticism regarding the lack of a globally coordinated fiscal and monetary response to the COVID-19 crisis, which has manifested as a sudden, worldwide shock. How much harder would it be (has it been) to coordinate a global response to a climate change crisis that manifests over years, decades or even centuries?
While we note that human activity, not nature, causes many pandemics, many of the same factors that mitigate environmental risks may also minimise the risk of virus pandemics. These include reducing the demands we place on nature by optimising consumption, shortening and localising supply chains, and decreasing pollution. Achieving these behavioural changes is within our reach as we emerge from the pandemic in the months and years ahead.
The response to both virus pandemics and climate change requires the same fundamental shift. We need to shift from optimising primarily for the shorter-term performance of systems to ensuring, equally, their longer-term resilience through investing responsibly. As a responsible investor and custodian of clients’ funds, we have a responsibility to assess all risks, including non-financial risks, i.e. environmental, social and governance (“ESG”) risks. ESG considerations are an integral part of our fundamental credit and investment analysis process and risk-return framework.
Once we have assessed these risks, as an active investor, we can choose to express our views in one of two ways, either by choosing to embargo a company and reduce our exposure to zero (we can do this because we are not benchmark cognisant). Alternatively, we can choose to invest and ensure that we price risks appropriately. In both instances, there is an opportunity as a capital provider to champion change by engaging companies on the issue of climate risk, along with a host of other ESG risks, as it relates to their business.
Transitioning from sustainability to resilience
In a working paper published by Harvard Business School, researchers have studied whether, during the 2020 COVID-19 induced market crash, investors differentiate across companies based on a firm’s human capital, supply chain and operating crisis response.
Using data derived from natural language processing of news around corporate responses to the coronavirus crisis, they found that companies with more positive sentiment exhibited higher institutional investor money flows and less negative returns than their competitors.
This is especially true for companies with more salient responses (Cheema-Fox, LaPerla, Serfeim and Wang 2020). The analysis period covered in this working paper ranged from the market high of 3,373 on February 20th 2020 compared to market low of 2,447 on March 23rd 2020, during which the S&P500 experienced a 27% decline.
Human capital, supply chain and operating crisis responses were selected as critical drivers of investor behaviour and stock returns during this period, given the impact of the crisis on supply chains and labour. The hypothesis is that more positive public sentiment around corporate responses to the COVID-19 crisis will mitigate investor distrust during the market collapse. During a period of volatility and crisis, how a company responds could increase investor confidence and make the company more resilient to the market shock.
At the time of writing, COVID-19 has not yet been contained globally, and markets are still in flux. We note, however, that this working paper aims to quickly understand market volatility to shed light on an ongoing and evolving crisis, building on a limited but growing literature that examines the quality of corporate responses during sharp market declines, such as during the financial crisis (Flammer and Ioannou 2018).
While COVID-19 represents a global growth and fiscal shock, the risks are particularly pertinent in South Africa, given elevated pre-COVID-19 unemployment rates and fiscal strain, evidenced by particular prior concerns about the lack of stabilisation in the government’s debt trajectory in the medium to longer term. Locally, our main concern regarding the bond market remains the strong link between lacklustre economic growth and a weakening fiscal position. The impact of the recent COVID-19-related events elevates this concern considerably.
More specifically, this points to the rising debt burden of the state, even considering the most recently tabled expenditure-restrained budget, which carries significant implementation risk. This continues to threaten the country’s sovereign risk profile and places pressure on domestic funding costs. As regards how quickly the SA economy can bounce back once lockdown restrictions are fully lifted, the duration of the virus cycle will be critical in determining the economic recovery trajectory.
Policies that are put in place to build economic resilience should have a strong focus on predominantly environmentally friendly initiatives. The most important of these would be a systematic approach to decarbonising our energy sources, but not at the expense of a host of other social imperatives such as open markets, robust institutions, economic growth, low unemployment, education, and skills development. Other measures that would serve to improve the long-term health and sustainability of communities and businesses would be policy initiatives and investments into securing the future supply of sustainable food and commodities. The risks to food security have been laid bare in South Africa in the wake of the recent Land Bank liquidity crisis.
When it comes to resilience, a major priority is building the analytical capability to truly understand, qualitatively and quantitatively, corporate vulnerabilities against a much broader set of scenarios, including, notably, physical events. Markets may better price in risks (and, in particular, climate risk) as the result of a greater appreciation of physical and systemic dislocations. It is our role as responsible investors to have a better understanding of the range of possible outcomes the counterparties we invest in on behalf of our client funds may face in an AC world.
In the absence of a clear virus inflection point in the near term, corporate balance sheet strength and earnings, and cashflow resilience remain critical measures of credit quality across the asset classes Futuregrowth manages. In our view, the likelihood of continued operational disruptions as our economy re-opens and the inevitable second (and third) wave of infections mean that contingency planning, scenario assessment and risk management will remain an increasingly important element of business strategy and the robustness of our credit assessments going forward.
To address the vast inequalities that have become painfully apparent during the crisis, we will need to redefine accountabilities. Shareholder returns at all costs will, and should, give way to basic principles, such as a company’s treatment of staff, suppliers and customers. As the Harvard Business School working paper we refer to earlier suggests, society and investors at large will likely become more sensitive to the quality of a corporate’s response to crises and demand more accountability in future.
The investment industry, too, will need to step up to its responsibilities as long-term holders of capital. In the before-coronavirus (BC) world, it was indeed a rarity to attend a conference or field questions from asset consultants and others without discussing ESG risks at length. While this may suggest that sustainability has at long last entered the mainstream, those of us who work in this space know that we are far from a world where all investors fully, meaningfully and consistently consider and appropriately price for ESG risks. This must surely change and, when we emerge from this crisis, the AC world that awaits us demands that responsible investment is the only acceptable norm.
Futuregrowth’s journey of integrating ESG risks into our investment process over the better part of the past 20 years has shown us that it is a process and a journey of ongoing learning that we continue to walk, along with the counterparties in which we invest.
During the 2008 crisis, sustainability shot to the top of the agenda in the investment industry. This pandemic quite clearly shows that we haven’t done nearly enough to improve the resilience of our financial systems, economy, health services and physical environment.
A number of analysts estimate that in the wake of the COVID-19 pandemic we could experience the most significant drop ever recorded in global emissions of between 2 and 2.5 bn tons as a result of globally coordinated recessions, as opposed to good climate policies. Even an annual reduction of this magnitude still falls short of what would be required to limit global warming to 1.5°C above pre-industrial levels. Global emissions would need to fall by 2.8 bn tons a year by 2030 to limit warming to 1.5°C.
This crisis is going to reshape the world going forward fundamentally and will, no doubt, have long-lasting effects on the global economy and societal behaviour. These structural shifts could leave the global economy even more vulnerable to other crises down the line; or we could choose to build a better, more resilient economy that puts us in a far stronger position to survive the next crisis we face.
By continuing to collaborate and coordinate our actions, the public sector, private sector and communities have an opportunity to reimagine a more sustainable way forward for the world. We believe responsible investing can play a crucial role in bringing this vision to life, provided asset managers use this opportunity to engage flexibly and responsibly with companies that may be failing in their crisis management responses, while maintaining a long-term focus on investment decision-making. It will be critical in the weeks and months ahead that we leverage the power of collaboration to ensure that the standards of engagement on these key issues are not dropped during this crisis.
Both the climate crisis and the unfolding virus pandemic threaten the one thing we all care deeply about: the health and safety of our loved ones, and by extension the health and safety of our communities, country and fellow global citizens. We will need to start now if we want to build a sufficiently resilient economy that can withstand any financial or physical shocks that come our way. We can and must do better. DM
Emerging Stronger Webinar: On Friday, 3 July at 12h00 CAT join Daily Maverick Associate Editor Ferial Haffajee in conversation with Nicole Martens, Head of Africa & Middle East, PRI, and Tarryn Sankar, Head of Listed Credit at Futuregrowth Asset Management discussing whether the Covid-19 crisis will change the way we make investments, and what we invest in, and whether we can afford to make the transition to responsible investing. Register here: https://event.webinarjam.com/register/132/1nzzwf61
Published on www.futuregrowth.co.za/newsroom.
Futuregrowth Asset Management (Pty) Ltd (“Futuregrowth”) is a licensed discretionary financial services provider, FSP 520, approved by the Registrar of the Financial Sector Conduct Authority to provide intermediary services and advice in terms of the Financial Advisory and Intermediary Services Act 37 of 2002. The fund values may be market linked or policy based. Market fluctuations and changes in exchange rates may have an impact on fund values, prices and income and these are therefore not guaranteed. Past performance is not necessarily a guide to future performance. Futuregrowth has comprehensive crime and professional indemnity in place. Performance figures are sourced from Futuregrowth and IRESS.
Che Guevara hailed from an Irish family.