ESG Strategies Are Working in the Downturn
By Derek Deutsch, Portfolio Manager, ClearBridge Investments
The financial market downturn has negatively impacted most U.S. companies and their stocks, some more than others. Essentially out of nowhere, companies are being forced to respond to an almost completely new public health reality. Management teams are trying to conserve costs while treating employees compassionately, ensuring safety and allocating capital appropriately.
At times like this, do environmental, social and governance (ESG) investment strategies matter?
Yes, absolutely. Our core belief with ESG is that better companies will fare more favorably over the long term – and absorb markets shocks more readily. That is largely proving true: considering ESG issues when making investments could lead to better overall decision making.
After a very strong 2019, many market participants – including us – thought valuations were elevated entering 2020, especially as U.S. equity markets expanded into a record-breaking 12th year. That has led many investors to start shifting from offense to defense. While almost no one anticipated the COVID-19-induced recession, we were among those who transitioned to a slightly more defensive position in the fourth quarter, adding less-cyclical stocks to our portfolios and trimming stocks we judged expensive.
ESG fund managers generally are more thoughtful in positioning their portfolios. This is not limited to capital preservation but takes in managing human and financial resources too. The pandemic is an opportunity for companies to demonstrate how they consider the wants and needs of all stakeholders.
The largest social risks from the pandemic response are layoffs, which loom increasingly large with more than 22 million unemployed – and climbing. Some companies have been forced to cut employee compensation and benefits and cut payments to suppliers. For restaurants and service companies, there are very real risks of spreading infection from poor hygiene practices.
People remember how companies respond to crises. Companies that do the right thing – by all their stakeholders – should be able to improve their reputation and brand equity. Those that fall short will do themselves no favors in the long term, possibly to the point of failing.
Focusing on companies with strong financial and ESG attributes can help to preserve capital during volatile market environments. We firmly believe, based on many years’ experience, that owning businesses with sustainable competitive advantages most often leads to long-term success.
Seeking out companies with solid, clearly delineated ESG strategies can help investors to identify enlightened companies that are making decisions to ensure sustainable and responsible growth for the long term. Stronger social policies and responsible corporate governance may help companies weather storms and be quicker to rebound.
Companies and governments are being forced to think deeply about disaster preparedness, on multiple levels: supply chain, technology and physical infrastructure, remote work and employee benefits must be considered. Technology companies levered to enterprise spending should benefit from the accelerated transition to remote work and cloud-based solutions.
Even after the pandemic ends, these enhancements could be sustained as companies realize the importance of investing in durable, flexible systems.
It is too early to tell how the pandemic will change consumer behavior. Trends such as the transition from bricks and mortar to online retail may gain momentum. This could make some jobs and skills less relevant. Investors should look for forward-thinking companies that are proactive in adjusting their business models and training employees for the jobs of the future.
To read ClearBridge’s recent comments on ESG investing, click here.
Derek Deutsch is a Portfolio Manager at ClearBridge Investments, a subsidiary of Legg Mason. His opinions are not meant to be viewed as investment advice or a solicitation for investment.
Derek Deutsch, Portfolio Manager, ClearBridge Investments
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