At a tipping point?

Why the social element of ESG could soon be receiving the same level of scrutiny as environmental factors.

• The global pandemic has accelerated and elevated social concerns within the sustainable investment debate.
• The growing activism of clients is being turned on asset managers, pushing them to hold themselves to the same standards that they demand of others.
• A lack of tangible data has historically made it harder to directly link social impacts to financial performance.
• Looking five years ahead, we believe the growing awareness of the systemic nature of social issues should ensure that they get the prominence that climate change receives today.

Five years ago, climate change was a topic that most investors acknowledged as a systemic risk, yet, when discussed in terms of portfolio management, it was largely viewed as an externality that had failed to manifest itself in financial returns. How times have changed. 

Now, nine out of ten of the world’s largest economies have committed to achieving net-zero carbon emissions, one third of the world’s asset managers have joined the Net Zero Asset Management initiative, and, more importantly, the economics of the fossil-fuel industry have been transformed by the internalisation of climate change into companies’ business models. What was previously a movement led by activists has now become an economic imperative that promises to reshape the world.

Social concerns to the fore

In the (we hope) soon-to-be post-Covid world, social concerns have been elevated in the sustainable investment debate. While investors are increasingly vocal about issues such as human capital management, there is frustration that a lack of tangible data, and limited evidence that social considerations are linked to financial outcomes, are hindering progress towards achieving a more comprehensive inclusion of social factors in portfolio decision-making. Despite these challenges, however, we believe that investors may well be at the same tipping point in the social debate that climate was at five years ago. The question is, therefore, are we about to see the transformation of the social dimension of ESG into a transformative economic force too?

Businesses as social enterprises

The Covid-19 crisis reminds us daily that all businesses are de facto social enterprises. Institutional investor surveys, such as the Edelman Corporate Trust Barometer 2020 report,[1] highlight the increased prominence of social issues. These findings are echoed in a recent Pensions Policy Institute report in which 75% of pension schemes surveyed expected members to become more concerned about social considerations in investment decisions. [2]

The rising awareness of social matters for individual savers reflects their immediacy through their own experiences or in their own communities. The increased focus on stewardship by pension funds and wealth managers is a mechanism for elevating these concerns, and one that provides a voice to a wider range of stakeholders and makes all investors potential activists now.

Hard to measure

The broad scope and qualitative nature of social factors can make it hard to measure impact and understand how to implement the management of these risks effectively. The growing awareness of the topic is also increasing the range of factors being considered, which adds to the challenge. However, the complexities of a topic matter little if there is a growing clamour for tackling stubborn systemic challenges. 

Institutional investors are increasingly using their voice for social matters too. The absence of data is being filled by engagement activities that call for greater disclosure and clear goals for achieving inclusive and diverse workforces. Strong governance is needed to translate easy corporate rhetoric into tangible action through clearly defined goals. Here, shareholders are calling for stronger evidence of intent, starting at the board and executive level, and exercising their voting power to underscore the imperative for change. 

Future of human capital

The investment industry is also being forced to look at its own performance on social matters, which is often sadly lacking when it comes to inclusion and diversity. The growing activism of clients is being turned on asset managers, pushing them to hold themselves to the same standards that they demand of others. While more is needed, programmes such as the Thirty Percent Coalition, #100BlackInterns and Women Returners are signs of progress. 

When backed by greater efforts on improving cognitive diversity, the industry can be helped to break out of its own echo chamber. The power of social movements is illustrated by the success of #100BlackInterns, which has rapidly spread to over 20 industries beyond financial services and morphed into #10000BlackInterns.

Mental wellbeing

The rapid recovery from the Covid-induced recession is revealing skill shortages and changing how companies organise human capital management. In many industries, the pattern of work may never be the same again. Covid has demonstrated that flexibility can bring productivity benefits, as well as giving access to a more diverse talent pool. The arrival of children in many a video conference call has humanised the work experience for many and reminded us that there is a life beyond the office. The pandemic has also raised awareness of mental illness as the downside of those productivity gains. There is now greater appreciation that mental wellbeing needs to be managed in the same way as physical wellbeing.

Focus on supply chains

It is not solely in direct activities that social matters are coming to fore. Issues in supply chains, such as forced labour, have come increasingly to prominence, often amplified by political and legal pressures. Scrutiny of supply chains is notoriously hard, but the positive side of social media and the internet is that issues can be rapidly revealed and can cause damage to reputations and sales. While traditional reported social data remains elusive, other forms of information can be even more powerful.

Collaborative action is an important element of achieving greater corporate accountability. Not-for-profit organisations, such as the Workforce Disclosure Initiative,[3] have played a central role in driving improved transparency in all forms of human capital management to fill the data gap.

Five years ahead

Looking five years ahead, we believe the growing awareness of the systemic nature of social issues should ensure that they get the prominence that climate change receives today. It is an opportunity for business to show leadership and innovation – especially in a world where so much of government policy has been outsourced to the private sector.

The activism of shareholders needs to be built upon and turned into engagement, with a forward-looking perspective on a multi-stakeholder world. The data will follow and should be no excuse for inaction. Behaviour is visible and shapes outcomes more than reporting will ever do. The prescient corporation will see that effective stakeholder management is about ensuring future relevance.  

[1] https://www.edelman.com/sites/g/files/aatuss191/files/2020-11/Edelman%202020%20Institutional%20Investor%20Trust_FINAL.pdf

[2] https://www.pensionspolicyinstitute.org.uk/sponsor-research/research-reports/2021/2021-04-22-engaging-with-esg-environmental-social-and-governance-factors/

[3] https://shareaction.org/workforce-disclosure-initiative/

Authors

Newton responsible investment team

Responsible investment team