How responsible investment can restart the economy

Writing for the Financial Services Faculty, Jonathan Minter discovers whether responsible investment can or should drive the pandemic economic recovery.

The global stock market’s 11-year bull run ended in spectacular fashion on February 20th. By March 23rd, the FTSE All Share Index was down 34% - and most other major global markets were down at least 25%.

A combination of panic over Covid-19, an oil price war between Russia and the OPEC countries and the knowledge of a looming economic crisis led to a record-breaking route. 

In the US, Monday 9th March, dubbed ‘Black Monday,’ recorded the worst single day losses since the 2008/2009 recession. Three days later, US markets experienced ‘Black Thursday’ – where US stocks suffered their worst losses since the 1987 stock market crash. The following Monday, ‘Black Monday II’, saw even larger falls again.

All in all, March was a tough period for fund managers and stock pickers. Since then, markets have partially recovered. However, this recovery is by no means even across the board.  

For example, Barclays traded at 181.34p on February 19th. When the market closed at the end of July, it was trading for just 101.26p, having fallen over 11% in the preceding week due to fears that it was facing a wall of defaults. In contrast, at the time of writing, the likes of Amazon, Microsoft and Apple are all now trading far in excess of their pre-Covid peaks. 

Dividends cut

One of the more notable results of the crisis has been a large scale cut to dividends across the UK equities market. In its Q2 Dividend Monitor report, Link Asset Services notes that 176 companies cancelled their dividend pay-outs, and a further 30 cut the dividend amount. This represented three quarters of Q2 dividend payers, the biggest quarterly fall on record. 

The report describes the cuts as: “truly a record breaker. Not by a whisker, nor by a nose, but by a mile.”
It appears that income biased fund managers remain not too panicked. Describing his conversations with some of these managers, Alex Imrie, partner – investment management at Smith &

Williamson, notes: “The general impression is they're not changing strategy, and a number seem fairly positive for the year ahead.” 

While many companies were forced to cut dividends for economic reasons, this was not always entirely the case. Banks and insurers were lent on by regulators to cut theirs in order to remain well capitalised.  Also, in an environment where governments are providing liquidity to the market, it may have proven a PR disaster to pass some profits on to shareholders.

“There may also be companies thinking their competitors will struggle over the next year, so they may be trying to keep funds available for M&A,” Imrie adds.

In its report, Link Asset Services suggests: “For 2021, dividends are likely to rebound quite sharply, increasing as much as 29% year-on-year, though we caution that this is based on broad-brush assumptions at this point.”

ESG and responsible investing

In June, MP Bim Afolami published Unlocking Britain: Recovery and renewal after Covid 19, which called for the creation of a £15bn ‘recovery’ fund to be allocated by the British Business Bank to various fund managers to invest in small- and medium-sized non-listed businesses.

Whether or not the government ends up acting on Afolami’s report, it raises the question of whether fund managers may look to potentially use their investments to spur economic recovery, as opposed to purely focusing on maximising returns.

While no doubt many managers would welcome the additional revenue stream of such a recovery fund, it would be important for there to be a separation between these funds and client funds.

The idea of using client money to push an economic recovery as a moral imperative, instead of investing it most in line with the client’s investment objectives is clearly a controversial subject.

Stephen English, Head of AIM Stocks/IHT Fund Manager at Blankstone Sington, describes this as a ‘moral maze to which there may be no map.’

Both English and Imrie note that different clients will have different risk appetites which need to be considered.

English notes: “While virtuous, each and every client would have a different appetite to fund a recovery, presuming that a trade-off exists between having to take on much higher risk to capital to fund such endeavours.”

Meanwhile Imrie adds: “I wouldn't want to impose my moral view on clients’ money. It's incumbent on me to have that conversation with clients, and discuss strategy that may well encompass ESG and understanding what their goals are.”

Uptick for ESG funds after lockdown

ESG - or Environmental, Social, and Governance – investing involves including these non-financial factors into investment considerations. This has become a popular topic for investors and managers alike. 

Global fund network Calastone noted ESG funds had seen strong capital inflows since Covid-19, as investor interest continued to grow in the sector. It described the popularity of ESG funds as ‘exploding’, noting the past four months to July had seen record amounts for investment inflows. July alone saw inflows of £362m for UK-based ESG focussed funds. This came amid despite equity funds over all suffering outflows June and July.  Overall, Calastone noted funds experienced a £240m outflow in July. 

This was already a growing field, and Imrie notes that this trend has accelerated since the start of the pandemic. In general, he notes, companies that follow ESG principles have generally been more resilient as they tend to be more forward looking, with stronger governance. 

Imrie is not alone in this belief. In its document How did European Sustainable Bond Investments Perform During Covid-19 Turmoil, Insight Investments notes a correlation between companies which scored better in their ESG ratings and general resilience. It notes: “Sustainability-focused portfolio tilts and allocations are likely to have helped investment performance in this period.”

Of course, a fund looking at ESG factors when assessing investments is not a guarantee of success. Insight Investment notes that ‘Green Bonds’ did not outperform conventional ones, for example.

ESG-minded managers invested in online clothes retailer BooHoo, as the company was able to point to high ESG scores from several Index ratings agencies. The company was found to have used suppliers paying substantially below minimum wage and did not provide adequate PPE during the Covid-19 crisis.   

The ensuing share price collapse will have left many investors in ethical funds scratching their heads as to why they were invested in a company with such issues in the first place.

English notes: “Supply chain risk was seemingly overlooked or underweighted in the rating agency’s formulaic ESG framework.” 

Although there are strong arguments that a focus on ESG matters can help in the long term, it is important for managers to truly understand the companies they are investing in, to avoid ESG becoming another tick box exercise, as appeared to be the case with BooHoo. 

Market concentration and future threats

With ESG investing becoming more popular, and certain market segments struggling, there is a potential risk for the fund market to become too concentrated in a smaller pool of shares.

Giving a UK equity market overview, Nick Wood, Head of Investment Fund Research at Quilter Cheviot, highlights two trends: 1: Growth investing has become more popular over the last decade, and 2:  there has been a trend towards greater passive investment. He adds the latter point means: “Whilst many passives invest across the market, technology companies, for example, get bigger, whilst energy and financial get smaller, this also exacerbates the shift.”

That said, Wood notes there are still plenty of funds that offer diversification.

For managers, this might mean a little more work, but Imrie notes: “It's part of my job as an investment manager to know what investment opportunities are out there and go and get access to them for my clients. This is why managers and our firms should be spending time identifying opportunities.”

While the market has somewhat recovered from its March lows, it remains well below the February peak and the situation is by no means over. A second wave of Covid-19 remains a real threat. The ongoing damage to the UK economy could cause jumps in unemployment and inflation, as well as a recession. This is also not mentioning the fact that the UK Government still intends to complete its negotiations for leaving the EU by the end of the year. 

Woods says it is the combination of a ‘bad’ pandemic response along with the risk from a disorderly Brexit outcome that is his biggest worry. 

There are also regulatory worries. Chancellor Rishi Sunak recently announced a review of Capital Gains Tax (CGT), while calls to review inheritance tax changes could see business property relief (BPR) cut. Any move to cut BPR would be counter intuitive to the Government’s aim of growing the British economy, however, says Lisa Best, Head of Financial Services Content at Intelligent Partnership, as the companies who most benefit from it are just the types of firms needed to drive growth and economic recovery.

Managers looking to combat these risks have a few topics to consider. A diversified portfolio will help smooth out some of the bumps, as will making sure a good portion of investments are relatively liquid to enable the manager to react. English points out that managers must accept they can only ever know a relatively small amount about an investment given how complex the real world is and that, as a result, the outlook and whole investment case can literally be upended almost overnight.

About the author:

As well as freelance work, Jonathan Minter is senior editor at Intelligent Partnerships. He was formerly group editor of The Accountant and International Accounting Bulletin, as well as car finance title Motor Finance.