How sustainability will be fundamental to progress

It is becoming clear that the effects of the COVID-19 pandemic will reverberate long after the outbreak has passed.

Our “inescapable truths” are the economic and disruptive forces identified by Schroders before COVID-19 as shaping the medium-term outlook for economies and markets.

They predicted a slowing economy and unprecedented disruption, and implied active stock selection and risk management would be critical.

We explain how sustainability will be fundamental to understanding this shift, focusing on six key areas that point to a changing role of the corporate sector in society.

1. Re-writing social contracts: responsible “saint” companies will outperform the “sinners”

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Figure 1: Sector-relative performance of companies announcing responses to COVID-19, since start-Jan

^{Source: Company announcements, JUST Capital, Schroders. Past performance is not a guide to future performance and may not be repeated.}

The current consumer attention on companies’ roles in society – and the gap between “saints” and “sinners” – is likely to accelerate.

The “inescapable truths” predicted subdued growth and low inflation against a backdrop of disruption from populist politics, technology and climate change. How companies respond to an environment of considerable change will be critical, and investors will need to be more agile than ever.

Unlike with the global financial crisis, where scrutiny was focused on the financial sphere, this crisis is prompting introspection and scrutiny of corporate behaviour in general – with consumer sectors facing more scrutiny than most.

Those behaving responsibly towards their employees or redirecting capacity to social challenges to support public relief efforts have outperformed, according to our research.

We put together Figure 1 to show the equity returns of companies taking different actions.

While performance is measured relative to sector peers to adjust for the different pressures facing each sector, we recognize that many actions may not be a direct cause of outperformance.

However, the relationship between the responses to COVID-19 and the equity market’s appraisal of their value is telling. Those hiring workers, relaxing attendance policies or offering financial assistance, for example, have been appraised positively.

We believe those companies with a longer-term outlook are likely to be those still standing once the crisis has passed.

2. Companies must be better prepared for “black swan” events

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Figure 2: Growing frequency of natural disasters and terrorist impacts	Figure 3: Economic policy uncertainty index
Source: Munich Re (left), Institute for Economics and Peace (right)	Source: PolicyUncertainty.com

Our Chief Economist and Strategist Keith Wade has observed that the economic effects of crises like pandemics can reverberate for as long as 40 years.

Events such as terrorist attacks, political disruptions, natural disasters and other climate risks are coming thicker and faster, making so-called “black swan” events more frequent.

Their causes may be different, but the business effects are similar: supply chains are disrupted, movement slows and demand falters. Compounding the impact, industry supply chains have become longer, more diverse and with thinner inventory buffers.

In many cases companies will be forced to build “inefficiencies” into their supply chains and operations – some slack that has periodic value to compensate for its structural costliness. In other cases, smarter sourcing decisions and choices over where operations are located will help.

Figure 4 below show that Emerging Asia and Latin America are the regions most exposed to pandemic risks, and the sectors most exposed to physical climate risk are oil & gas producers and electricity (Figure 5).

By combining companies’ geographic exposures with the risks each country faces, we can assess companies’ exposures to pandemic threats, physical climate risks, water stresses, and socio-political risks.

Figure 4: Geographic exposure to pandemic risks

^{Source: Schroders 2020.}

Figure 5: Top and bottom 3 sectors exposed to physical climate risks

^{Source: Schroders 2020.}

3. Political reprioritization: governments will come under pressure to tackle societal problems

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The crisis will place growing pressure on governments to reverse the policies that have exacerbated growing inequalities within societies. There is clear evidence that the current crisis has hit poorer people harder than wealthier counterparts.

There are disadvantages in accessing healthcare, poorer underlying health and the need to continue working in poorly paid and badly protected jobs.

Figure 6: Growing social pressure for political redirection

^{Source: Gallup, Bennet Institute, Schroders}

On the other hand, the speed and stringency of the response in many countries underlines the capacity of governments to achieve significant social change quickly.

The crisis may prove a springboard to a round of political reform. Fiscal stimulus packages to help the economy through the crisis are already ripping up the rulebook. There is an opportunity to create stretching policy initiatives to tackle some of the worst societal problems.

Social pressure for political reform has been growing for more than a decade, particularly in developed economies. Indeed, rising populism is one of the identified “inescapable truths” of the next decade.

This crisis may provide the impetus to release that pressure through changes to political systems. Consideration of sustainability factors will be key for investors as concerns that have led to political upsets in recent years come under the spotlight. We expect health, education, employment and other welfare policies to attract more focus in the future, channelling public funds into investment opportunities in related sectors.

Figure 7: Annual growth in EU regulation by topic since 2000

^{Source: Global Regulation database, Schroders}

Those impacts are likely to be predominantly sectoral. By tracking trends in regulation across topics and sectors, we can help identify companies facing bigger risks. Companies in the publishing industry, for example, may already face greater regulatory risk than those in the pharmaceuticals and packaging sectors. We can see that the latter sectors may be ripe for regulatory change.

As investors, we can then analyse and question companies directly on their exposure and readiness for new regulatory pressures.

Figure 8: Growth in regulation by sector since 2000

^{Source: Global Regulations database, based on change between 2000-02 and 2016-18 averages}

4. Employee protection: supporting vulnerable workers

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As industries such as the restaurant and hospitality sector ground to a halt during lockdowns, job and wage security have since hit all-time lows. More than 80% of the global workforce of 3.3 billion has been affected by full or partial workplace closures. Lockdowns are expected to wipe out 6.7% of working hours globally in the second quarter of 2020, according to the International Labour Organisation. That’s equivalent to 195 million full-time workers.

Figure 9: Unionization and inequality in the US

^{Source: World Bank, Knoema, 2020}

Many of those job losses will be transient, but COVID-19 has highlighted gaps in employee protection that will receive continued scrutiny. An increasing number of workers are in casual or “gig” economy roles. An absence of basic benefits such as paid sick leave, healthcare or retirement provision have become major social concerns.

Figure 10: US gig economy size ($bn)

^{Source: MasterCard survey, 2020}

We expect the definition and responsibilities of employers will change as a result, as will the role of trade unions advocating on workers’ behalf.

In short, employees will have an increasingly powerful voice, particularly in industries that have historically been able to treat workers as dispensable resources to squeeze. The redistributive effects of unionisation are likely to prove increasingly important, with the share of major economies’ workforces in insecure roles rising.

Figure 11: Benefits most mentioned by workers via employee reviews

^{Source: Employee review sites, Schroders}

We expect the crisis to drive a range of changes to industries. In particular:

• Protection of contractors’ and gig workers’ rights such as via minimum or living wage rates, which are now being compounded in EU regulation likely to be paralleled globally. Companies that have already made commitments on living wages and benefits will be better placed.
• Stronger employee bargaining and trade unions. Countries with higher levels of unionization have lower levels of inequality. Unions are likely to receive a boost in their already-stabilizing fortunes as policymakers’ focus on inequality rises. Countries, companies and sectors with higher union representation will likely be better placed to adapt.

Our proprietary ESG tools include a range of measures to assess companies’ readiness to adapt to the growing importance and influence of employees. Below we have ranked the most common benefits employees cite, as well as levels of satisfaction they report through popular employee review sites.

Figure 12: Average ratings from employee review sites by sector (top and bottom 3 sectors) (1-5 scale)

^{Source: Employee review sites, Schroders}

Our analysis suggests that corporates’ focus on basic benefits such as sick pay and health insurance will be increasingly critical to their licenses to operate. Companies that pay low wages will similarly face margin pressure as demands to pay sustainable incomes grow.

Workers’ satisfaction with their employers will provide an indication of the disruption companies face as the pendulum of power moves back toward employees.

5. Globalization under pressure: long-term structural shifts in global supply chains

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Figure 13: Global trade growth spluttering over the last decade

^{Source: World Bank}

Supply chains have forcibly localised during the COVID-19 outbreak. Many countries have taken steps to secure domestic food supplies over exports, potentially leading to shortages in import-reliant countries. The US pharmaceutical and biotech industry has been exposed as vastly reliant on China for the majority of its key active pharmaceutical ingredients.

Post-crisis, companies may begin, once again, to lean on their most trusted global partners, whatever their location. But the crisis is likely to resurface existing concerns on the over-complexity and opaqueness of global supply chains. Difficult discussions are re-emerging on trade barriers and border taxes. The US-China trade tensions last year felt pivotal, but actually accounted for less than a quarter of recent anti-trade measures.

Figure 14: Crisis has prompted a “buy local” response (US)

^{Source: Cognovi Labs}

All point towards long-term and structural shifts in global supply chains and headwinds to companies reliant on complex and diverse global value chains. Companies will need to build out their choice of suppliers, even if doing so raises costs and reduces efficiency.

Figure 15: Top 10 most exposed industries to “trade tension” supply chain risk (indexed scale)

^{Source: Schroders}

Consumer products and internet retail sectors are the most exposed to existing trade tensions in the US, for example.

On a company level, this allows us to analyze threats to supply chain disruption of some of our key holdings. Similarly, our assessment of supplier payment lead times shows the pharmaceutical and mining sectors among the slowest to pay their suppliers.

Companies need to have both visibility and agility in overseeing their supply chains, as well sufficient investment in technology systems to help manage their performance.

6. Technology adoption: driving workplace changes and new sales channels (but there are risks)

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Digital life has been fast-tracked. The crisis has forced many corporate leaders to reprioritise remote working and to strengthen their digital tools in case of future lockdowns or other disruptions.

Several new opportunities are emerging, both for growing categories such as video conferencing and for companies able to exploit the digital workplaces and channels that have quickly matured.

Businesses have become increasingly reliant on global travel to build relationships, a trend that looks threatened. Reflecting that shift, video conference provider Zoom currently has a larger market capitalization than the world’s seven largest airlines combined (as at 30 June 2020).

The “new tech bubble” also saw a 74% rise in online purchasing during March 2020, and a rise in gaming. Consumers have spent around 65% more on video games compared to the same period last year.

Whether these new habits will last depends in a large part on security. Technology platform launches have been rushed out, causing potential shortcuts in data security protocols. Data security threats are heightened, and companies may be more vulnerable.

Figure 16: Business travel has been growing in real terms ($USbn)

^{Source: World Travel and Tourism Council}

Figure 17: Year-on-year change (%) in web traffic January to May 2020

^{Source: SimilarWeb}

Companies with higher levels of research and development compared to their peers are likely to be at the forefront of deploying breakthrough technologies, as suggested in Figure 18. Businesses taking those steps with a firm handle on data security and privacy will be at an advantage.

Figure 18: Research & development to sales, top 5 sectors

^{Source: Refinitiv, Schroders}

The volume of cyber security alerts in Figure 19 indicates the sectors most affected to date by security issues.

The different data sources available allow us to paint a risk management picture of companies across key affected industries and enable comparisons across peer groups. Companies that have invested in good data security technology and leadership will be the least exposed to fines and poor customer experiences.

Figure 19: Highest volume of cyber security alerts issued by CISA

^{Source: CISA}

Conclusion: Sustainability will be fundamental to progress

The COVID-19 crisis has been a structural whirlwind, with the potential to fundamentally transform how companies interact with their stakeholders for the better over the long term.

Through our proprietary analysis tools, we have the ability to draw upon global trend data and company data to assess which sectors and companies are likely to emerge less scathed, both from the crisis and other “black swan” events.

The COVID-19 crisis has highlighted the importance of ESG (environmental, social and governance) analysis, measurement, and engagement.

And as an active investor, we actively question those we believe are falling short of the ever-important expectations of stakeholders.

Schroder Investment Management North America Inc.
7 Bryant Park, New York, NY

For more information please go to www.schroders.com/us/institutional

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@schrodersUS

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