Environmental, Social and Governance (ESG) investing is increasingly becoming a phenomenon on the world’s capital markets. ESG is a demand-driven aspect of investing, as today’s investors, especially the younger generations (partly gen. Y, the millennials, and younger), are not only concerned with the return and risk of their investments, but also the impact they are making with them. This impact can range from workplace diversity to environmental footprints, including hundreds of factors that are examined periodically for a growing number of companies worldwide. Based on their factor scores, companies are ranked and benchmarked against each other.
In the previous episode we talked about the environmental factors of ESG, now let us have a look at the social pillar of ESG, which can be quite difficult to grasp as there is a huge range of metrics that can constitute a social issue, including anything from labour relations, to workforce diversity, to procurement and supply chain practices.
Social factors have still a long way to go as they have not been in focus of ESG products, only 14% of social ratings products aggregated by the Global Reporting Initiative (GRI) targeted an investor audience in 2017. This suggests either that investors do not believe these factors are likely to improve investment outcomes (and therefore do not demand social products and services), or that there is something about social factors that make them difficult to package for investor use. Investors tend to focus on near-term risks and financial returns which is problematic because social performance mostly improves investment outcome in the longer term.
Of the 580 products aggregated by GRI 97% of environmental efforts and 80% of governance efforts target investors as the primary audience, when it comes to social efforts, only 14% similarly targeted investors.
But these social factors are not as complex and abstract as they might sound and as data quality is continuously improving, there has been a strong correlation outlined between social issues and financial performance. Social factors consist of people-related elements like company culture and issues that impact employees, customers, consumers, and suppliers – both within the company and in greater society.
- Employee pay/ engagement / training and development: A growing body of evidence suggests that strong corporate culture and engaged employees make the best performing companies. A Swedish bank, Svenska Handelsbanken is committed to create positive work environment, where personal development is strongly encouraged and 93% of the managers are chosen internally; all employees own the same share capital as the CEO and as employees are the second biggest company shareholders, profits are shared fairly; and the bank works with unions to decrease wage disparity between men and women. As such, Sycomore Asset Management decided to include the company in their portfolio and adjusted the bank’s beta from 1.22 to 0.95 through their specialized analysis. Choosing the standardised valuation method (Gordon-Shapiro approach) – which is the most adapted method to valuate a bank – the target price was increased by 17%.
- Diversity and inclusion in hiring and in awarding advancement opportunities and raises: Investment firms can integrate diversity, including gender and race at the company and board level into their investment research process. For example, BGC’s study found that companies with above-average diversity of leadership teams can show up for a greater payoff from innovation, meaning the percentage of revenue from newly launched products and services, and higher EBIT margins. Six dimensions of diversity were included in the study – gender, age, nation of origin, career path, industry background, and education. Companies that have more diverse management teams have 19% higher revenue due to innovation. This shows that diversity is an integral part of such companies operating in industries where innovation is key to growth.
- Public stance on social justice issues, as well as lobbying efforts: As Walmart decided to restrict the types of firearm ammunition it sells in September amid the tension surrounding high-profile shootings, it became more favorable for socially minded investors and shares rose 1% to an all-time high following the news.
Asset owners and portfolio managers overseeing trillions of dollars seek to incorporate ESG considerations into their investment process where investment firms have a unique sales opportunity to consider. By combining the product-level ESG features of an investment with the clients’ profile based on their ESG preferences and thus recommend products that suit them best in a hybrid advisory model. In order to understand where to start, click here and download our whitepaper, which gives a detailed overview of the growing popularity of ESG investments and explains the benefits of incorporating ESG-based profiling features in the investment ecosystem.
Stay tuned! We are going to publish one more blog post in this topic about the G(overnance) pillar.
 NYU Stern, Putting the “S” in ESG