Asset managers ignored pandemic risk and now must learn from their mistakes

This article is authored by David Wighton, a former business editor of The Times and a columnist for Financial News. It originally appeared on May 30, 2020 in The Times : https://ow.ly/Ssdx50zZGfo

Davos is a waste of money, according to Keith Skeoch. The chief executive of the investment giant Standard Life Aberdeen has decided that the very idea of the global elite meeting in a Swiss ski resort for the World Economic Forum is “divisive” at a time when the world needs to unite to defeat coronavirus. The ￡3 million his firm shelled out every year could be better spent, he said.

Quite possibly. His shareholders and investors might well question whether they got value for money. Not because he went. Or because he took along a big team, including a chap to play the bagpipes at his whisky bar reception. But because he didn’t seem to pay much attention when he was there. Anyone who has been to Davos recently could scarcely have missed one of the top recurrent themes: the risk of devastating pandemics. Bill Gates always seemed to be there warning about the threat.

At last year’s conference, the forum published a report with Harvard University declaring that business was “on the front line of an evolving microbial war”. The lead author was Peter Sands, a respected figure in the City who used to run Standard Chartered and now heads the Global Fund to Fight Aids, Tuberculosis and Malaria. In the paper, Mr Sands cited work by Larry Summers, the former US Treasury secretary, forecasting that the average annual costs of pandemics would be $570 billion a year. That is two thirds of the costs of global warming predicted by the Intergovernmental Panel on Climate Change. Yes, that’s right. Almost as costly as climate change.

Some businesses were particularly vulnerable, it warned, such as in the travel and tourism sector, plus those with complex supply chains. But luckily there were some simple steps that businesses could take to mitigate the threat. They could, for example, check whether their “business continuity insurance policies exclude infectious disease outbreaks”.

Imagine if Mr Skeoch had read that. Imagine if he had told his team that discusses environmental, social and governance (ESG) issues with the companies that Standard Life invests in. But he didn’t. And many of those companies are now likely to miss out on billions of pounds worth of insurance claims, some of which will ultimately come out of his investors’ pockets.

It would be unfair to single out Mr Skeoch. No big asset manager seems to have taken much interest in pandemic risk. None of them warned the companies they invested in or avoided investing in companies that were particularly exposed.

In recent years, most investment firms have made a big thing about identifying the environmental, social and governance risks that companies are underestimating. It is one of the ways they justify their fees. Standard Life has focused on dozens of specific risks in areas such as climate change, executive pay and diversity. It has found time to worry about regulatory risk for manufacturers of single-use plastic products. But it is, it says, “not possible to cover the whole myriad of challenges”. Unfortunately, one challenge was the threat of a pandemic that could trigger a 30 per cent fall in global share prices in a month.

“Asset managers have failed investors in their funds by not paying attention to the risk of infectious disease outbreaks,” says Mr Sands, who has spent years trying to persuade senior industry figures to take the risk seriously. So why didn’t they? Part of it may simply be herd instinct. No other asset managers were taking it seriously. In their defence, some suggest governments ignored it too. But even if true, that is beside the point. Investors should not simply follow governments. When it comes to climate change, they proudly claim they are way ahead of many governments.

For some asset managers, focusing on environmental, social and governance issues is mainly about how investors can make the world a better place. For these investors, pandemics are less interesting than climate change because companies can’t do much directly to reduce the risk of outbreaks. Yet most asset managers say that ESG, or sustainable investing, is fundamentally about investment returns. “Sustainable investing for us is just about risk — being aware of non-financial risks,” Mark Wiedman, head of international at Blackrock, the world’s biggest asset manager, said recently. In that case it would seem undeniable that the pandemic has been a serious failure for sustainable investing. Yet far from seeing it as a failure, asset managers have been trumpeting the crisis as a great vindication. They have rushed to point out that shares in companies with high ESG ratings have tended to outperform marginally since the markets slumped. Investors focused on sustainability look for resilience in companies, which has proved a strength in the crisis, they say.

Perhaps, but even if that outperformance lasts it doesn’t get asset managers off the hook for ignoring pandemic risk. “The industry needs to get better at highlighting the right issues before they materialise,” says Hans-Christoph Hirt, head of stewardship at Federated Hermes, one of the pioneers of sustainable investing. There has been a tendency to focus on issues “including climate change . . . that were more on the agenda of more people”, he adds.

Many in the industry concede that it is partly the “agenda” of end investors and lobby groups that determines which sustainability issues asset managers focus on. That comes close to admitting the claims of the cynics (including some at the very top of the industry) who say that for many firms sustainability is less about investment performance or making the world a better place and more about fund marketing.

According to Mr Sands, the pandemic is a “moment of truth” for ESG managers. “Is it an attractive marketing approach or is it truly about understanding the underlying risks that could impact investors?” If it really is about risks, asset managers must admit their mistakes and consider what other unfashionable issues they might be ignoring such as cyber-threats or artificial intelligence.

If they don’t it will be hard to avoid the conclusion that it is mostly just marketing. A bit like Mr Skeoch dissing Davos.