The S in ESG: why it matters

Important information: The value of investments and the income from them can go down as well as up, so you may get back less than you invest.

When I spoke about environmental investing last week, I explained how it’s becoming easier to invest for a greener future. It’s an area receiving a huge amount of attention right now, as concerns around climate change and deforestation (to name a few issues) become ever more pressing.

And while there’s still a lot more to be done on the environmental side, questions surrounding how companies treat their own people and the societies in which they operate can be just as important.

That’s where the Social side of Environmental, Social and Governance (ESG) investing comes in. Our companies (and funds) are now expected to meet certain social standards - standards that include maintaining fair labour practices, ensuring consumer protection, and acting in shareholders’ interests. Investors across the board no longer accept profits that come at any social cost.

However, because the S side of things is an area that has always had a far broader focus than E and G, it can be difficult to define. Couple this with the fact that environmental concerns are garnering much-needed attention, and that corporate governance standards are ever evolving, and S can fall under the radar. But just like E and G, there is good reason for investors to start giving the S some serious consideration.

S coming to the fore

Social standards can be tough to get your head around, so one simple way to think about them is how a company relates to its stakeholders - whether they be shareholders, employees or customers.

In this respect, it’s beginning to make more sense to more people. The Black Lives Matter movement has called into question how companies handle issues around race and inclusion, while COVID-induced disruption to supply chains and workplaces has forced companies to adapt to ensure their customers are still catered for. As NN Investment Partners explain: “A heightened focus on the wide-ranging social implications of the pandemic has shifted the emphasis from E to S in the last couple of months.”

The ongoing economic burden of the pandemic has made companies’ approach to redundancy another prominent issue. Earlier this year, BA’s move to cut up to 12,000 jobs prompted protests from unions and politicians, while pub-chain JD Wetherspoon came under fire for saying its staff should not be paid when its pubs closed at the start of lockdown. Companies that have received government support are also likely to come under tighter scrutiny than before.

All this has seen a spike in popularity for so-called ‘social bonds’, where capital raised is used to fund social projects. Over the first half of 2020, $50bn of social bonds were sold - more than double the whole of 2019.

What difference do my investments make?

The whole fund industry, and particularly those in the ESG sector, are paying far more attention to the social side of things now. Fund managers can have a bearing on their holdings’ social practices - one way to keep the pressure up is by simply excluding sub-standard firms from their portfolios.

For instance, after reports emerged that fast-fashion brand Boohoo was reportedly paying its workers as little as £3.50 an hour to make garments for the firm’s Nasty Gal brand, several ESG funds withdrew their investments in the firm.

Often, ESG ratings are based on data provided by the company itself, which can give rise to misreporting or inaccuracies like these. Remarkably, MSCI, the index provider, had given Boohoo a positive rating just weeks before the news broke, highlighting in particular its above-average supply chains. Evidence, if it were needed, for an extra layer of due diligence that ESG strategies often provide.

Scandals like this will hopefully be few and far between going forwards - as we have seen, more and more attention is being paid to companies’ social standards, which keeps the pressure up on firms and ESG rating agencies alike, who will look to avoid the reputational damage that follows from poor social practices.

Social companies make for good companies

All this should be a win-win for investors - as well as building for a fairer society, it’s also becoming increasingly clear that socially orientated companies make for good investments.

On the one hand, such companies avoid scandals and the subsequent selloffs that come with shoddy practices. On the other, they tend to be building for a long-term, sustainable future. They’re keeping up with market trends and demands, and typically can point to strong management guiding their decision-making. In other words, they’re the sort of companies that most of us look to invest in.

Moreover, funds that take their companies’ social responsibilities seriously are also likely to demonstrate the same sort of risk analysis and screening processes that we’d expect from any competent management team. As Bryn Jones, manager of the Rathbone Ethical Bond Fund (who uses a combination of negative and positive screening in his investment process) explains: “We do a lot of the things you’d expect from a mainstream manager in looking at the fundamentals of a business, so that’s not in any way sacrificed. In fact, it’s augmented by additional levels of due diligence.”

S is becoming an increasingly important factor in investors’ decision-making. Not only is that good for society - it’s good too for returns.

Important information: The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Investors should note that the views expressed may no longer be current and may have already been acted upon. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. The Investment Manager’s focus on securities of companies which maintain strong environmental, social and governance (“ESG”) credentials may result in a return that at times compares unfavourably to similar products without such focus. No representation nor warranty is made with respect to the fairness, accuracy or completeness of such credentials. The status of a security’s ESG credentials can change over time. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

Topics Covered

ESG investments; Funds; UK