Environmental and governance factors are more easily quantifiable and applicable to investment strategies than social factors, but investors could be missing out on vital risk management tools, potential performance gains and growing client interest by marginalising the ‘S’ in ESG investing.
Governance has long been a focus of investors when analysing investee companies, and in recent years the emergence of benchmarks and other analytical tools has made the link between environmental factors and performance clearer than ever.
Fewer such metrics exist for social investing, which is broadly defined as targeting companies that create “positive, long-term effects for society on a national, regional and local level as well as financial returns for clients and shareholders”, while working with customers, partners and suppliers “that uphold similar values”, CEO of Gresham House Tony Dalwood explained.
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“It is vital that we contribute to increasing awareness of the importance of making a social impact on an individual and collective scale,” he added, noting the firm works with the Key Worker Living programme on its British Strategic Investment fund.
Risk management
In addition to the “ethical case for strong management of social issues”, there is a growing body of research indicating that “businesses that look after their people tend to outperform over the long term”, responsible investment analyst at EdenTree Investment Management Jon Mowll said.
However, Mowll explained that the social factor does not get “the attention it deserves in ESG investing”, largely because key areas such as job satisfaction “are not easily quantifiable”.
The investment case for a social focus is therefore most evident in risk management, where poor treatment of employees, business partners and other stake holders can lead to regulatory or political pressure on investee companies.
Perhaps the best known example of this in recent times was the mass sell-off of Facebook shares in early 2018 as a result of its role in the Cambridge Analytica scandal.
“Social impact is difficult to define, measure and quantify, which can bring with it an extra level of complexity in giving it equal importance alongside the environmental and governance considerations of a company,” said Sawan Kumar, stewardship analyst at Evenlode Investment.
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“Investors often find it difficult to predict the long-term consequences of risks associated with social considerations. The long-term nature of those risks can often distort their materiality.
“[However] an analysis of a firm’s non-financial as well as its financial risks can highlight both positives and negatives for any firm’s overall investment prospects.”
Stewardship analyst at Sarasin & Partners Therese Kieve agreed that “there can be little doubt that how businesses treat their staff, customers, supply chains and indeed local communities can materially impact their outlook”, evidencing “legacy” US retail bank Wells Fargo, which “still struggles with [it] to this day”.
For years the bank had created “millions of fraudulent customer accounts”, Kieve explained, which “led to a boardroom shakeup, change in CEO, the departure of other senior management, and left the share price languishing”.
She added that the “rise of e-commerce” should be on the radar for investors concerned about social risks as the market has become a “mechanism for increased exploitation, with workers forced into increasingly ‘flexible’ but ultimately more precarious employment”.
Kieve said: “The hidden costs of this can be enormous. One impact may be more tangible than we think, with the coronavirus outbreak posing the troubling question: what happens to ‘gig economy’ workers who are required to self-isolate but not entitled to sick pay?
“Poor treatment of customers or workers by companies makes for bad business.”
Upside potential
While risk management factors associated with a social focus are more tangible, the lack of related metrics and benchmarks has made it more difficult for investors to equate strong social policies with long-term outperformance.
However, last week (3 March) Amundi’s thematic equities business CPR Asset Management announced the launch of a “first-of-its kind” global equity fund, which aims to deliver “potentially higher financial returns” by investing in companies set to prosper as a result of their capacity to “attract capital, human talent, consumers and regulatory approval”.
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Speaking to Investment Week co-manager of CPR Invest – Social Impact Yasmine de Bray said the firm had to build its own method of analysis in-house, owing to a lack of suitable existing metrics.
CPR’s analysis shows that “social aspects are starting to deliver good performance”, according to de Bray, with the fund’s investable universe populated with “a lot of companies that have a greater ability to innovate and to
generate growth”.
De Bray noted the example of French cosmetics firm L’Oréal, which “15 years ago went through a cultural shift, investing a lot in diversity and the wellbeing of employees, in addition to its digital marketing efforts”.
“This combination allowed them to gain a lot of market share and have very strong financial outperformance thereafter,” she explained.
L’Oréal’s share price is up by around 300% from January 2005 to January 2020, nearly doubling the 152.9% return of the Euro Stoxx index over the same period, according to FE fundinfo data.
“Companies that have an edge on their competition also often have an edge on the management of the social aspects of the company,” de Bray said.
Global head of ESG investments and research at Candriam Wim Van Hyfte added: “Companies that scores well on metrics like women empowerment, diversity policy, equality in pay at board and management level pay out higher dividends and less exposed to risks.
“Even ESG investment products, like those from Candriam, or some new investment products focused on diversity often outperform traditional benchmarks.”
Source: impact investing
