The evolving S in ESG
September 24, 2020
Mindful investors are becoming increasingly concerned with creating impact in the areas of environmental, social, and governance (ESG) criteria. Interest has been growing exponentially for years, and at this pivotal time in human history, the ‘S’ or social component is proving particularly resonant.
As news outlets and political leaders regularly state, we’re living in an unprecedented time. The human experience of day-to-day life, which is arguably the endpoint of the ‘S,’ is under intense pressure from multiple factors, such as the COVID-19 pandemic and the global ricocheting of the Black Lives Matter movement.
Investors are interested to learn how social investment criteria can be meaningfully identified and measured. Is it an opportunity or a liability? How can a business adjust its operations and performance to give the social aspect of ESG more focus? Does it require a rewrite of the business rulebook or just a reinterpretation? Is it possible to invest wisely and still make a difference? In essence, what does the ‘S’ really mean?
Defining what’s relevant, and where
Since the portfolio area’s recognition in 2005, to 2020, ESG had reached $40.5 trillion in assets under management and is an increasing consideration for private companies. This is due in part to top-down changes like the EU’s sustainable finance taxonomy and Hong Kong’s compulsory ‘comply or explain’ reporting framework, and in part to increasing investor and consumer interest in ESG-related performance and transparency.
It’s a growing concern for potential employers— and recruiters—too. For some companies, promoting socially-conscious business strategies is essential for attracting and hiring Millennial and Gen Z employees, who want to work for values-driven, sustainability-focused companies.
The social element of ESG spans different interests, contexts, and success metrics—any issue, according to the UN-supported Principles for Responsible Investment (PRI), that relates to the rights, well-being and interests of people and communities. Aspects of the ‘S’ highlighted by the PRI include human rights, health and safety, freedom of expression, employee relations and diversity.
Even so, clearly defining the’ S’ in ESG isn’t always easy as beyond globally relevant criteria, the question of which social issues are connected to a particular company’s performance is unique to its business and industry.
Bloomberg’s own Gender-Equality Index is a case in point. Developed in 2015 as a platform for firms to voluntarily disclose their gender-related metrics, in 2020, a record 325 companies reported, showing that 6% of CEOs, 19% of Executives, 27% of Senior Managers, 37% of Middle Managers and 49% of Entry-Level Employees are women. Understanding how women are represented in firms’ corporate pipelines helps Bloomberg improve data quality—and real-world outcomes—in this area.
Assessing for valuable impact
COVID-19 is shifting the focus of leading ESG investors, with several buy-side firms upping their analysis of how companies treat employees during the pandemic.
By at least one measure, investors now favor improved diversity and human rights disclosures more than in 2018—with an increase in the number of proposals and their level of shareholder support.
Still, given that reporting of social factors remains limited, evaluating the impact of ‘S’ issues on recent investment outcomes can be challenging. Specificity around what constitutes a pro-social effort—precious-metals companies addressing human rights issues in supply chain relationships or sourcing, for example—arguably makes ‘S’ analysis easier at the company level. When looking at a given company, investors can use reported data to look qualitatively at how its business actions align with a broader mission or identity.
Expanding that kind of assessment across a fund or other investment entity is more challenging. This is because firms operating in different markets are forced to calculate sustainability-related data in many different ways, which skews the comparability of the data set (or more accurately, data sets). Additionally, a lack of transparency allows firms to present the numbers how they want them to appear.
However, it’s expected that defining, measuring and reporting against ESG criteria will be more mainstream in the coming years. Bloomberg is driving the charge for standardization, transparency, and accountability, with a goal to increase standardization across the board. Bloomberg prioritizes transparency behind the calculations, by considering aspects like self-selection bias or ‘signatory saturation,’ which sees some firms signing public statements intent with a minimal standard of accountability. There is also an opportunity for exchanges and regulatory bodies to collaborate and put out standardized reporting mandates driving accountability across sectors.
As the definition of a company continues to evolve in a more purposeful direction—and as a company’s responsibilities to customers, employees, suppliers, and the environment move toward being on par with the responsibility to shareholders—so too does the demand for more relevant and meaningful metrics around ESG and its business value.
Embracing the malleability of social investing
Like any other investment option, the ‘S’ comes with both risks and opportunities. The COVID-19 pandemic has highlighted the strategic importance of sustainable and impact investments, as the challenges of self-isolating, sanitation and working from home come under the spotlight.
A 2008 study by Dutch academics presented clear empirical evidence for a positive correlation between corporate social and financial performance. Benefits were observed in reduced operating costs and financial risks, enhanced efficiency and competitiveness, and increased corporate reputation and consumer confidence.
Often, aligning the success of a company’s socially conscious strategies with performance is difficult to attribute to specific ‘S’ factors. Still, it’s widely accepted that meaningful social evolution at a company tends to happen as part of a long-term strategy.
Embracing diversity in hiring may require more time and resources in HR, but has proven to pay back in dividends. Furthermore, organizations with above-average gender diversity and levels of employee engagement outperform companies with below-average diversity and engagement by 46-58%. Companies with higher than average diversity have 19% higher innovation revenues. These are significant numbers that show the potential for opportunity in this space.
With global markets weathering the fallout from the coronavirus pandemic and evaluating lessons learned, a spotlight is falling on socially conscious business and investment strategies. It’s crucial to recognize that the malleability of the ‘S’ factor and its relationship to the changing attitudes of investors, consumers and employees means its impact on business performance may be ever-changing—and vice versa. As better assessment criteria, more disclosures and more transparent data across ESG factors emerge, investors will be able to evaluate investments holistically and ultimately identify and seize new opportunities.