Social inequalities, a rising theme even before COVID-19
Social inequality has become a major issue for investors. In a previous publication (Drut, 2020)1, we demonstrated the following:
– The growth of social inequality is a stylised economic fact that has accompanied the third wave of globalisation since the early 1980s;
Given the above, the social theme was already becoming extremely relevant for investors. Recently, several initiatives demonstrated this fact.
For instance, over the 2016-2019 period, we showed that the ‘S’ criteria in company selection (via a ‘best in class’ ESG approach) has a real impact on the prices of listed companies, particularly in Europe (Roncalli et al, 2019).6 Indeed, a portfolio combining long positions in the highest rated companies (top 20%) and short positions in lowest rated companies (bottom 20%) would have generated annualised returns of +2.9% in the Eurozone and +1.6% in North America over 2018-2019.
Furthermore, we are the first to have developed a methodology for selecting companies based on an assessment of the relative participation of companies in reducing social inequalities in their country of origin (see below). Notably, we are demonstrating that such an investment universe, at the very least, offers a performance in line with the broader universe (in this case, the MSCI World).
Other studies have demonstrated a negative link between the pay dispersion between CEOs and median salaries and stock market performance.7
To summarise, the growth in social inequality since the 1980s is a major economic fact, the economic consequences of which are now well known. Investors had already started to integrate such themes into their investment decisions before the coronavirus crisis.
Up until the COVID-19 crisis, however, investor mobilization on social inequality had been (very) limited by certain factors:
– First, a lack of global (and sometimes regional or local) consensus on the levels of inequality deemed acceptable from a social and economic point of view. Between Europe and the Anglo-Saxon world, for example, the differences are stark. Interestingly, in response to the pandemic, Anglo-Saxon countries prioritized the preservation of economic capacity over the health response; and
The pandemic, a tipping point for inequality?
We believe that the pandemic will allow us to turn a corner. Should inequality levels rise significantly around the world, the consensus issue will become obsolete. Moreover, new methodologies are being developed to address the lack of tools available to investors. The combination of these two factors should accelerate the integration of inequalities into investors’ investment policies and practices.
First, the health crisis in most developed countries has put the issue of social inequality at the center of political and media attention through two main channels:
– The blatancy of social inequality embedded in the epidemic itself due to:8 (a) the inequality in the face of the disease, with the most disadvantaged social groups and regions paying the heaviest price;9 (b) inequality in terms of access to care in some countries; and (c) inequality in the response measures to the disease, with the most disadvantaged social groups hardest hit by containment measures, further increasing inequalities (notably through the partial de-schooling of children from families with the lowest incomes); and
There will be consequences to this double turnaround, in particular in terms of the redistribution of added value.
Second, the health and economic crisis will have major social consequences, contributing in the short term to increasing relative inequalities in the following ways:
– A massive increase in unemployment in most developed countries (almost 37 million people filed for unemployment benefits in the US between early March and May 9), with the overwhelming brunt of the employment decline concentrated among lower-wage workers11;
This would be consistent with the historical evidence, which shows that inequalities have increased after pandemics.
Policy response to address the rise in inequalities
It is possible that a political and economic response will arise to address rising inequality via:
– The implementation of social policies, associated in particular with massive budgetary transfers to the most disadvantaged groups;
From a macroeconomic perspective, this should result in:
– An increase in tax and social transfers in most developed countries;
These developments should be supported by the synchrony of the crisis in all countries, possibly limiting the risk of fiscal ‘loss of competitiveness.’ In a sense, since all countries are facing the same challenge, it is quite possible that the argument of capital flight risk for not implementing these types of policy is now less admissible.
The pace of these developments is obviously difficult to assess and will depend heavily on political developments in individual countries. In this respect, two main types of scenarios are possible: (I) the rapid adoption by existing governments of ambitious social agendas (the ‘New Deal’ model); and (II) the initial pursuit of ‘business as usual’ policies by the governments in place, which is quickly challenged by large-scale social movements leading to new political forces (‘populist’ or not) coming to power on social and/or anti-elite agendas.
What implications for investors?
The implications of these developments for investors will obviously be key. It is interesting to note that in an ESG approach for selecting companies, the ‘S’ factor has contributed relatively more to financial performance since the start of the coronavirus crisis, particularly in the United States. Indeed, our ESG research shows that the big ‘ESG’ performer since the beginning of the crisis has been the ‘S’ pillar in North America. It should also be noted that the investment universe we have built, based on the relative contribution of companies to social inequalities, outperformed its index by 119 basis points over the period February-April 2020;
From a macroeconomic point of view, there are two major issues for investors:
– A priori, the more a country was mired in inequality before the crisis, the more the response could be massive at the end: investors should therefore fully consider this factor in their assessment of the relative economic situation of different countries;
From a microeconomic point of view, and in terms of company assessment, we believe investors should:
– Incorporate the issue of inequality into their assessment of companies, notably according to: (i) their contribution to public finances; (ii) their salary policies for the highest earners; and (iii) their wage policies and profit-sharing policies.
Ultimately, we believe that the social issue, which was already becoming increasingly important in the eyes of investors, will become a central focus in the years to come.
1. “Rising Inequalities: A Real Threat for the Economy”, Bastien Drut, January 2020, CPR AM Focus Sustainable Development.