How ESG has made strides during COVID-19

Year in review: Waratah Capital portfolio manager on how mandates have continued to gain momentum amid pandemic crisis

How ESG has made strides during COVID-19

While the COVID-19 pandemic hurt some areas of the investment landscape, environmental, social and governance (ESG) investing took another big another step toward greater adoption in Canada in 2020.

“The space continued to gain traction,” says Jason Landau, EVP and portfolio manager at Waratah Capital. “We are seeing more investment managers get involved, and more importantly, corporates are placing a greater emphasis on ESG than in the past. The wave is coming, so you’d better be ready for it. There has been really good adoption across the spectrum.”

Waratah is an expert in the ESG space and has taken a unique approach with its Waratah Alternative ESG Fund, a long/short fund that is not exclusionary, instead shorting the companies with poor ESG practices.

“We think it is incredibly unique and the right way to do it from a risk management standpoint,” Landau says. “Shorting bad actors on the ESG side is alpha generative – think of an energy company with no ambitions to change. Their future liabilities may very well be brought forward, so we can get active on the short side of the portfolio as the world’s energy demand transitions. Additionally, we can short companies impacting their cost of capital and lessen their ability to be repeat offenders, driving down their ability to raise new money.”

Waratah also capitalizes on emerging themes on the long side of the portfolio and is willing and able to provide capital to businesses transitioning to more sustainable practices. This approach helps give the company a complete view of the space. This year has been positive for Waratah’s ESG strategy, something Landau feels is reflected more broadly in the space.

“There are certain aspects of ESG that have been amplified because of COVID,” he says. “A lot is on the social side, things like how companies treated their employees – raising salaries, handling sick days, paid leave and compensating for childcare. I don’t think the environmental side changed all that much – it continues to be at the forefront and most topical, but social and governance have gone through some unique changes this year. A lot of companies did away with buy-back programs; dividends were cut or suspended, and how they get reinstated will be interesting from the governance perspective.”

Yet it’s the impact on the social side that looks to be the lasting trend from 2020. Landau says the pandemic has really showed how certain companies behave, and he believes companies that are making the right decisions are the ones reaping the benefits.

“When companies do the right things for employees, they usually have strong fundamentals as well,” he says. “Those high-quality companies are usually high-quality on the ESG side. Businesses that make the right decisions on ESG tend to make the right decisions corporately, financially and fundamentally. Socially, incremental pay, treating of sick leave, benefits packages, etc., and how corporates will deal with those issues in the future, all came out of the COVID pandemic.”

When it comes to returns, Landau says 2020 has reinforced Waratah’s views about well governed companies resulting in strong returns. He also thinks that the environmental factor continued to make strides and that the social factor, which has traditionally been more challenging in terms of returns, will get there.

“There is a high correlation to boards and management teams that make the right decision for ESG and fundamentals,” he says. “Governance is not new; it has been topical for decades, and making the right capital allocation decisions within a governance framework creates shareholder value. Environmental, I think people will come around to realize there is a tangible benefit. Think of carbon taxes – it is a tangible cost that impacts businesses. If you have a company that burns less natural gas in their manufacturing process and figures out how to do so through technology advances, they will have a better cost structure, higher margins, earnings and ultimately share prices.”

When it comes to his outlook for the future, Landau points to a couple of factors. The first is a trend toward the sort of non-exclusionary approach Waratah uses. Landau says funds that do this have a greater ability to impact change.

“For example, I believe in investing in a utility company that historically had coal-fired generation plants but is raising money to build a renewable energy project,” he says. “That company may be on an exclusion list for many other ESG funds, but the best thing to do would be to invest in it, effectively making the bad better. That is more impactful than helping the good remain good. Our approach is to support companies that make the greatest positive change by providing capital to the business, accelerating the transition.” 

Overall, Landau believes ESG is here to stay and will only continue to grow in popularity in the coming years.

“It is the right way to think about investing, and your business if you are a corporation,” he says. “Happy employees deliver better performance, lowering cost and emissions drive higher margins, and the right governance decisions prove to be successful. I think we will see a day where a change in ESG ratings will be just as important as a fundamental equity rating change, but it will take time. In the meantime, there is an alpha advantage for those investment managers integrating ESG into fundamental investment analysis.”