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Social investing can often appear to be the poor relation in the environment, social and governance family. In theory, ESG investing covers each issue in equal measure. In practice, investors have tended to focus first on governance risks and more recently on climate change.
“In the past, a lot of companies hadn’t really highlighted social issues as being top of their agenda because they were in industries that were very focused on environmental or governance issues,” says Manjit Jus, global head of ESG research and data at S&P Global.
“They just didn’t feel social was relevant or key to their business, so they hadn’t emphasized reporting on those topics.”
Another ESG data provider puts it more bluntly: “Prior to Covid what we were hearing from investors was: ‘I understand the importance of governance and environment, but why should I even care about social?’”
The combination of a pandemic and racial injustice protests in the US and elsewhere, however, have changed all that. They have given a new urgency to social issues such as healthcare, education, diversity and employee rights.
From March onwards, the topic attracted so much attention from investors, researchers and journalists that many in the ESG industry have dubbed 2020 “the year of social”. But have the headlines and thought leadership pieces translated into meaningful change?
In the bond market, the answer is a resounding ‘yes’. Beyond question, this has been the year of the social bond.
The asset class, which had previously been overlooked by issuers and investors in the stampede for green bonds, suddenly came into its own as supranationals, governments and other public-sector borrowers rushed to raise funds to mitigate the impact of Covid, lockdown and economic recession. (See ‘Can social bonds survive Covid?’)
Elsewhere, hard evidence of the heralded shift to social is more difficult to find.
“Clearly with Covid, the social piece has come to the fore and companies are responding to that in terms of their own behaviours,” says Ian Ashment, head of systematic and index investments at UBS Asset Management.
“But so far, although there has been a lot of discussion around it, we haven’t yet seen that translate into significant money moving towards the social side on a standalone basis.”
Arleta Majoch, partner at sustainable asset manager Auriel Equity Investors, agrees.
“I’d like to say that I’ve seen more interest in social issues, but I haven’t,” she says. “If you look at the volume of ESG and SRI [socially responsible investment] products on investment platforms, the environmental theme is still dominant. We haven’t really seen the advent of social in larger volume asset allocation, which is what really matters.”
Bankers at BNP Paribas, who put together a basket of European equities based on social scores that was launched in late September, found that the stocks in it had lower valuations – and higher returns – than peers.
“This suggests investors still aren’t chasing the ‘S’ in ESG in the same way they’re chasing the ‘E’,” says Trevor Allen, sustainability research analyst at BNPP Markets 360.
What explains the lag between thought leadership and investment practice?
Daunting prospect
One explanation is that investors still find the prospect of engaging with social topics daunting.
Of the global investors who responded to BNPP’s most recent annual ESG survey, 46% said that social factors were the most difficult to analyze and integrate, versus 30% for environmental issues and 24% for governance.
The most frequent complaints are that the social sphere is too broad and that the topics it covers – everything from diversity and human rights to product safety and data privacy – are too subjective and too political.
“On the governance side there has long been a consensus on what the metrics should be and what weight they should be given; and the same has also become true for environmental issues,” says Yannick Ouaknine, head of sustainability research at Societe Generale CIB.
“Social issues have been seen as something much more local, which it is difficult to assess from an external standpoint.”
Armin Peter, global head of debt syndicate and head of sustainable banking EMEA at UBS, agrees.
We don’t see the same sense of urgency from clients on social issues that we do around climate
Chris Iggo, Axa IM
“In the capital markets everyone wants a number, standards, a benchmark – but social means different things to different people in different places,” he says.
This subjectivity, combined with the sensitivity of many social topics, also means that reliable and comparable data can be hard to come by.
Even if companies are prepared to disclose human resources information, which has traditionally not been the case, there can be privacy or regulatory issues. In France, for example, it is illegal to record details of employees’ race or ethnicity.
Another issue cited as a challenge with social issues, particularly when compared with the environmental side, is the lack of defined targets.
“With climate, we’ve all agreed on a 1.5 degree limit to global temperatures; now it’s a question of working out how we get there,” says Chris Iggo, chief investment officer for core investments at Axa Investment Managers.
“What we want to know is how companies are reducing their carbon footprint. That’s a clear metric and a clear pathway. Social issues are far more disparate and diverse. There’s not a single goal as there is with climate. It’s more difficult to articulate the problems and therefore also the solutions.”
Asset managers also report that, even in the age of Covid, environmental issues continue to dominate the agenda for their clients.
“People are interested in the whole of ESG, but the top priority is climate,” says Ashment.
“It’s one of the biggest environmental risks the world is facing, and asset owners both want to help with the transition and are also mindful of the risks to their portfolios of not taking into account what is going to be one of the main drivers of our markets in the next several years and decades.”
Iggo agrees.
“We don’t see the same sense of urgency from clients on social issues that we do around climate,” he says.
At the same time, there are signs that social issues have moved up the agenda for asset managers and their clients as a result of the pandemic and the Black Lives Matter protests.
Generalist ESG information providers report an increase in interest in social metrics this year.
“The demand for more reporting on social impact and particularly topics related to human capital is coming through strongly,” says Jus. “These areas are now front and centre for investors.”
Widening the conversation
Social specialists are suddenly finding themselves in demand. The S Factor, a Toronto-based data firm that has been focusing on social data for more than a decade, has this year for the first time had calls from some of the world’s largest investors.
At the moment, most of the enquiries relate to diversity and inclusion, but Bonnie Lyn de Bartok, S Factor’s chief executive, is hopeful that this will lead to a broader conversation.
“The advantage of the focus on diversity is that it has got us in the door, which in due course we hope will give us an opportunity to demonstrate the breadth of social issues we cover and highlight what else is relevant,” she says. “It’s a step in the right direction and I think it will grow from there.”
The Social Progress Imperative (SPI), a US non-profit that measures social outcomes at a national, regional and municipal level in more than 45 countries, has also seen a spike in interest in its flagship Social Progress Index from large global asset managers and owners.
“They are looking at how our data can be constructively embedded into their portfolios and they’ve dedicated really senior people to it,” says Brace Young, a partner at sustainable investment firm Arabesque Asset Management and a director of SPI. “This is definitely high on people’s agenda.”
ESG experts say this heightened interest reflects a rising awareness among investors that social risks can be material across a broad range of topics.
“People tend to think that social in the ESG context means child labour, modern slavery and other severe human rights abuses,” says Alexandra Mihailescu Cichon of ESG data provider RepRisk. “But there are many other social issues, such as occupational health and safety and diversity, that are being brought to the fore because of Covid and the racial injustice protests.”
Weaknesses exposed
Amy O’Brien, head of responsible investing at Nuveen, notes that the last year has exposed weaknesses in companies’ disaster planning, supply chain management, customer support policies and employee health benefits.
“The pandemic and the recent incidents of racial violence and injustice in the US are focusing a lot of investors, both institutional and retail, on the connection between global events, systemic risks, ESG factors and the corporate bottom line,” she adds.
The focus on social is not just about charity or philanthropy
Anastasia Petraki, Schroders
Anastasia Petraki, head of policy research at Schroders, agrees.
“If a company doesn’t take care of its employees with regard to things like working from home and having healthcare provisions in place, then its employees will be less productive and more likely to leave the company in the long run,” she says.
“The focus on social is not just about charity or philanthropy. We don’t believe that a company that regularly mistreats its employees has a sustainable business model or makes a good investment proposition.”
Mihailescu Cichon also highlights the reputational risks to companies from social issues.
“The expectations of investors, consumers, NGOs and regulators are changing all the time,” she says. “People want to know not just whether something is legal but also whether it’s ethical, sustainable and meets the needs of all stakeholders.”
For Iggo at Axa, reputational risks may even outweigh legal risks in the social sphere.
“If companies are seen not to be taking diversity and inclusion seriously, that will become apparent in the public domain and could have an impact on consumer demand for products or services, as well as investor preferences,” he says.
“Similarly, the way companies have treated their staff during the pandemic will likely have a lasting impact on both consumer and investor perception of those companies.”
At the same time, de Bartok notes that there are still limits to investors’ concerns around reputational risk. She points to a list of high-profile companies – including Tesla and Abercrombie & Fitch – that have faced little pushback on health and safety violations and even, in Tesla’s case, a class-action lawsuit on racism.
“The challenge we’ve had for 20 years is that we see bad social events happening, but no one seems to care until it hits the headlines,” she says. “Companies and investors are not proactive about it, they’re just reactive to bad PR.”
Even when issues do hit the headlines, the fallout may be limited.
Rio Tinto’s destruction of an ancient aboriginal site in Australia in May drew international condemnation and eventually prompted the resignation of the chief executive and two other senior executives but had little impact on the company’s share price.
The expectations of investors, consumers, NGOs and regulators are changing all the time
Alexandra Mihailescu Cichon, RepRisk
De Bartok also notes that not everyone in the investment community is yet convinced of the relevance of social issues.
“Social is a Pandora’s Box, and half the industry is not yet ready to have that conversation because they think it will compromise returns,” she says. “You have to prove to them that social has both big risks and also opportunities.”
Nevertheless, many investors are increasingly promising to hold companies to account on social issues.
“I think there will be much more emphasis on engaging with company management about their social policies, whether that’s internal corporate policies or how companies interact with broader society,” says Iggo.
Amanda Young, global head of responsible investment at Aberdeen Standard Investments, says this type of engagement is particularly important against the backdrop of the pandemic.
“Investors should be asking questions such as: what measures has the company taken to prevent the spread of the virus? What health and safety policies are in place? What are the near and long-term implications of Covid-19 on your management of human capital and labour relations?” she says.
“In the short term, such engagement can help businesses maintain their reputations and deliver a positive social impact. Over the longer term, it can help to make these businesses more sustainable – something that is, ultimately, in the interest of society, companies and investors alike.”
Petraki notes that one of the advantages of the pandemic is that it has made it easier to engage with companies on social issues. At the same time, she warns that the process will take time and will require support from other stakeholders.
Maintaining focus
Given the long-term nature of the commitment required, some ESG market participants wonder whether investors will be able to maintain their focus on social issues when and if the pandemic comes to an end.
“Social goes in and out of fashion,” says one ESG data provider. “People are starting to connect the dots and hopefully it will become a more established theme, but you have to wonder whether it will just fizzle out after Covid.”
Certainly, it seems likely that environment will continue to top the agenda for both companies and investors.
At the same time, proponents of social note that this year’s increased interest in the topic reflects a broader trend towards greater corporate social responsibility, exemplified by the US Business Roundtable’s statement on stakeholder capitalism in August 2019.
In a sense we’ve created a bit of a rabbit hole for ourselves with ESG… what it’s really about is just well-run companies
Chris Iggo, Axa IM
“Over the past 20 years the conversation on social issues has shifted from ‘this is really the role of governments’ to ‘corporates need to step up and play a leading role in the solution,’” says O’Brien. “We’re seeing a lot of chief executives being much more vocal about social issues, which makes a significant break with the past and sends a cascading effect to the market.”
Similarly, Iggo argues that the rise of social is not just about investors forcing companies to do the right thing but about understanding changes in society and how companies are responding to them.
“We are seeing exogenous shifts in the way society works, for example with working from home,” he says. “The companies that respond to this best will be the ones in the long run that perform better.”
He adds: “In a sense we’ve created a bit of a rabbit hole for ourselves with ESG because what it’s really about is just well-run companies. It’s about companies recognizing material risks and getting the best out of their workforce and their supply chains without creating too many external costs, which at some point they may have to absorb.”
