Mark Fattedad, Jarislowsky, Fraser
As the world collectively turns its attention to reopening economies, the emerging narrative is that many aspects of our lives and ways of doing business will not go back to the way they were before. New concepts like social distancing and economic shutdowns have presented individuals, businesses and governments with dramatic changes and challenges to consider. The pandemic has exposed weaknesses in a world of just-in-time global supply chains, it has shone a bright light on the realities of global inequality, and it has demonstrated just how fast carbon emissions can fall when people stop travelling. For us, it also highlights the opportunities of investing in a more resilient and sustainable future.
A Sharpened Focus on Environmental, Social and Governance (ESG) factors
The current pandemic has reminded investors why it is so important to consider issues such as the broader functioning of society and the health of other stakeholders when making long-term investment decisions. These so-called ‘non-financial’ elements that impact broader society have also had some of the most profound and widely distributed impact on businesses during the pandemic. As a result, it makes sense for investors in general to sharpen their focus on them.
In January, we wrote about the Business Roundtable's updated statement on the Purpose of a Corporation, which acknowledges that business decisions should deliver value to all stakeholders. The COVID-19 pandemic presents an opportunity for companies to demonstrate how they will walk the walk.
At Jarislowsky Fraser, we have been collecting data on corporate responses to COVID-19, believing that these could be important markers of good governance and firm quality. Early evidence supports this view. As noted in a Harvard Business School working paper, “companies with labour and supply chain practices that were seen as protecting employees and taking action to secure their supply chain experienced higher institutional money flows and less negative returns” during the February-March market selloff. In the short-term, many of these initiatives may increase costs. In the long term, we believe they will: bolster the resilience of the overall business and its place in the value chain; increase employee and customer loyalty and engagement; and improve relationships with regulators, governments and other stakeholders.
The Rise of ‘S’ in ESG
We are also seeing the rise of ‘S’, or Social factors, as a result of the pandemic’s dramatic human impact. Intuitively, things like good relationships with labour and suppliers as well as having happy, healthy employees and customers have always been relevant to businesses and long-term investors, though somewhat difficult to translate into financial numbers.
Today, we are seeing some companies recognize this by providing support at different levels for employees, customer, communities and vendors. Support for employees includes flexible work arrangements, extra pay and safety measures. Support for franchise and supply chains can mean flexible financing and logistics, and support for customers may require fee reductions/deferrals and flexible payment terms. In the near term, these actions can signal the resilience of a business while fostering customer loyalty and demonstrating that management is prioritizing the long-term business outlook over short-term profits. In addition, companies that prioritize employee retention over layoffs where possible are not only helping to limit the collateral economic damage of the pandemic but are also likely better equipping themselves to ramp up operations faster as the economy reopens.
Contributing to Solutions
Another significant trend that we are seeing is companies stepping up to contribute to finding solutions. In the healthcare sector, we have seen companies try to accelerate the development of vaccines, therapies and testing capabilities. On the industrial side, companies have repurposed operations and talent to provide much-needed supply. For example, French company Air Liquide joined a group of companies with manufacturing capability to produce 10,000 ventilators in 50 days. They did so at cost while absorbing the additional expenses related to setting up this unprecedented industrial program. On the technology front, companies are committing R&D for virus tracking and testing, prioritizing authoritative announcements on the pandemic, as well as providing free access to tools for education and healthcare sectors.
From an investor perspective, the ability of companies to be agile and innovative in solving societal needs may also help them be better positioned to capture emerging demand in a post-pandemic world.
Dividend Dilemma
A question that is on many investors’ minds is whether companies will continue to pay their dividends. We have had a chance to engage with a lot of companies over the past several months on this topic. Our view is that dividends are one tool to allow investors to participate in the success of the business. In today’s context, there is also a broader set of stakeholders who require support, including employees and suppliers, who are necessary for the long-term success of businesses and the economy. As long-term investors in businesses, we are supportive of Boards of Directors that take those considerations into account in setting near-term dividend policy. It’s ultimately about sound capital allocation, and we look to Boards to exercise prudent judgement within the context of their unique business circumstances.
Summary
The global pandemic will surely sharpen investor focus on ESG factors. Early evidence supports the belief that corporate responses to COVID-19 may be an important marker of good governance, as well as firm quality and resilience. The trend towards increased attention to non-financial factors is particularly prominent in areas typically referred to as Social, such as human capital management and supply chain integrity. The dramatic and potentially lasting changes also highlight companies that are able to innovate and orient their businesses during a crisis to support key elements of a functioning economy and society. Last but not least, the crisis provides an opportunity for companies to walk the walk in delivering value for all stakeholders.
We will continue to study this topic in the coming quarters as we seek to further understand the persistence of these effects over time, and the longer-term investment and analytical implications.
Mark Fattedad, CFA is Director and Portfolio Manager, Institutional Management, Jarislowsky, Fraser Limited.