The reverberations of the Covid-19 pandemic can be imagined through the lens of Edward Lorenz’s 'butterfly effect,' visual imagery that the MIT meteorology professor used to suggest that the flap of a butterfly’s wings might indirectly cause a tornado, which represents how small change can have large consequences.
Fixed income investors will increasingly engage companies
While climate-change impacts have spotlighted the environmental risks in investment considerations in recent years, the pandemic has spurred renewed social and governance issues.
This is not a new concept. The Principles for Responsible Investment, to which Morgan Stanley Investment Management has been a signatory since 2013, encourage investors to confront companies that are neglecting their workers' safety, or favouring executive pay and dividend payments over business sustainability.
Given the expectation that financing the pandemic response and recovery will primarily occur through debt issuance, fixed income investors will be asked to allocate more of their capital more often, increasing their dialogue and influence with issuers.
Companies will improve holistic risk assessment and disclosure practices
Our collective understanding of climate risk has evolved significantly over the past decade. As a result, we have seen new holistic approaches, such as the framework established by the Financial Stability Board's Taskforce on Climate-Related Financial Disclosure. Such frameworks help companies to understand their true exposure and vulnerability to climate risk and communicate this effectively with investors.
With new awareness of infectious disease risk, in particular, we anticipate the need for companies to develop and communicate holistic risk models applied to other sustainability risks beyond climate change, to give investors a clearer idea in advance of how securities might behave in a stressed scenario.
Investors will focus more on preparedness and resilience in the face of long-term risks
Much as companies develop business continuity plans to manage disruptions, we expect investors to account systematically for the resilience of their portfolios to exogenous shocks.
Investors in infrastructure developments, for instance, may question whether a bridge in a monsoon-prone part of the world is engineered to withstand climate-change related extreme weather events.
The goal is not to eliminate risk, but to minimise disruption and ensure a smoother recovery when disruptions do occur.
Investors do not expect companies to anticipate all the possible consequences when a butterfly beats its wings, but they will expect them to identify and address the areas where the effects may be most acutely felt.
For fixed-income investors, a greater focus on resilience in the long run may translate into more stable cashflows, less bond price volatility and lower default rates.
With many sustainability challenges like climate change, the effects might already be visible - for example, rising sea levels, changing weather and an increase in wildfires.
However, the major, and potentially more disastrous, consequences may only become apparent in years to come. In contrast, coronavirus has had an immediate and profound effect.
We believe this stark warning will serve as a wake-up call, further driving a modal shift toward sustainable investing and a renewed focus on sustainability risks and opportunities.
Navindu Katugampola is head of sustainable investing, fixed income & liquidity at Morgan Stanley Investment Management