Managing Risk Through Sustainability

By Emily Lawrence and Sharee Zlatkova, Northern Trust March 23, 2021 May 11th, 2021 Blog Post

The 2020-2021 academic year presented challenges for  educational institutions, pivoting their initial plans and strategies to support the transition to remote learning and other health and safety measures. In addition to the significant toll taken on human health and well-being, the scale of the economic impacts stemming from the COVID-19 crisis has also been stunning.

These circumstances called on endowments to provide more support for students, greater investment in IT infrastructure and updates to physical infrastructure to accommodate ventilation and other updated safety requirements.  These pressures coincided with endowment portfolios going through volatile markets.  The systemic nature of the pandemic, impacting the health of the portfolio and the impacts on the well-being of faculty, staff and students, taxed university resources along a number of dimensions, and demonstrates the importance of building resilience across functions to address broad based, systemic risks.  As endowments are reimaging long-term investing techniques  many are considering ways to integrate additional resilience in the portfolio, and turning to sustainable investing as an avenue.  This is an approach that acknowledges that environmental, social and governance (ESG) issues are business issues; when managed well, these factors can position a company for success. When managed poorly, they can lead to negative externalities that can result in reputational and financial risk. Here’s what you should know about how this approach aligns with endowment investment objectives.

MITIGATING RISKS WITH ESG

Companies also had to respond to this systemic distress by shifting business as usual to a new normal quickly.  Assessing how issuers navigated this transition highlights the importance of integrating ESG (environmental, social and governance) analytics into the investment process as a means of measuring broad resilience. Endowments can integrate ESG data to create a more holistic view of risks and opportunities — resulting in more informed investment decisions. According to a study done by Morningstar, 70% of sustainable equity funds ranked in the top halves of their categories and 44% ranked in the best performing quartile.

This observation can be seen across asset classes. Take for example the global developed equity index MSCI World Index versus the MSCI ESG World Leaders Index. MSCI designed the ESG index family to leverage ESG risk ratings to provide relatively low tracking error and broad market exposure.  The series launched in late 2007, and during its life cycle has largely performed in line with the world benchmark. The World ESG Leaders index outperformed its cap-weighted parent by 1.1% in the first half of the year, which was 84% driven by the security selection during this time period. This index’s performance was particularly strong during the significant volatility seen during the first quarter of 2020. Looking into the drivers of the outperformance, we group the securities by their individual environmental, social and governance scores into three categories of leaders, average and laggards.  Not surprisingly, the ESG leaders minus laggards are positive across all three metrics, with the spread in governance the largest at nearly 6%.  Companies that lead the pack on the social dimension outperformed their laggard counterparts by 4.4%, an interesting indicator underscoring the adept way the leader companies respond to their stakeholders.

Similar results can be found in different parts of the equity universe, including within emerging markets equities and in fixed income, across investment grade, high yield and municipal markets between ESG leaders and laggards.  Corporate ESG leader issuers also traded at tighter spreads during the market stress, an interesting characteristic when considering downside mitigation1.

ENDOWMENTS EMBRACE SUSTAINABILITY

The market stress brought on by the COVID-19 crisis has changed business as usual.  The data suggests that sustainable issuers have been better prepared to navigate the systemic shocks of the pandemic, and preserve value, demonstrating the case for sustainable investing.  Pre-pandemic, endowments were already at the forefront of recognizing the value of ESG analytics in investment decision making, with U.S. educational institutions allocating $378 billion to sustainable investing strategies in 2020, a 19% increase over 20182. This adoption rate isn’t surprising; many North American colleges and universities have embraced sustainability topics in courses and degree programs, and have adopted sustainable practices, renewable energy use in campus facilities; composting and recycling programs, and in planning for new construction.  Bolstered by the performance of sustainable strategies during the market downturn, and drawing on their institutional commitment to embracing long term sustainability in a multi-dimensional way, we anticipate that adoption of sustainable investing in the endowments space will only continue to grow looking ahead.

1 Downside mitigation refers to the use of investment techniques to manage risks through the incorporation of material, non-financial data.
2 US SIF Trends Report 2020

IMPORTANT INFORMATION. For Use with Institutional Investors/Financial Professionals Only. Not For Retail Use. 

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Emily Lawrence is director of sustainable investing for the Institutional Client Group of Northern Trust Asset Management.
Sharee Zlatkova is an investment associate of sustainable investing for the Institutional Client Group of Northern Trust Asset Management.

References and Resources

With Thanks to AGB Sponsor: Northern Trust

Emily Lawrence
Director, Sustainable Investing
Institutional Client Group
Northern Trust Asset Management
Northern Trust
EL84@ntrs.com

Sharee Zlatkova
Investment Associate, Sustaining Investing
Institutional Client Group
Northern Trust Asset Management
Northern Trust

Opinions expressed in AGB blogs are those of the authors and not necessarily those of the institutions that employ them or of AGB.