S is the neglected middle child in the ESG acronym. The term ESG (environmental, social, and governance investing) describes the attempt to reshape capitalism so it works better for society, particularly with the ominous threat of climate chaos making itself felt.
The term dates back as far as 2004 and has certainly gained traction in recent years. Bloomberg Intelligence estimated that global ESG assets are on track to exceed $53 trillion by 2025. This would represent more than a third of the projected total assets under management.
However, wedged between the dominating concepts of environmental and governance, the social dimension can often be overshadowed. This is partially because ESG is an attempt to cram a dizzying array of diverse ideas into one overladen portmanteau of initials, so it can be difficult to unpack the individual elements.
Then too, social investing can be a broad and somewhat tricky term to grasp, particularly when compared to the more sharply defined fields of planet protection and regulations. Research houses, investment firms, and other institutions all have different definitions of social investing. To keep the conversation simple, we can define social as covering how businesses treat and interact with significant stakeholders: consumers, their workforce, and the broader society in which they are hosted.
COVID-19 Highlights Social Relations
The social element of ESG came more to the forefront in the COVID-19 pandemic. As businesses worldwide grappled with the effect of lockdowns, it provided an opportunity to reflect on responsible investing and business practices in the private sector.
For example, 64 million women worldwide left or lost their jobs in 2020 as a result of the pandemic. Households in poorer countries also suffered with income losses and hunger becoming more common.
Within countries, employment and income losses were felt most acutely by the less educated, vulnerable women, workers, and youth. Lower incomes often translated into food insecurity for disadvantaged households, and a large fraction of children in poorer families, particularly in low-income countries, did not have the opportunity to continue learning during school closures.
Did you know …
- According to the United Nations Foundation, three of the top five global issues to watch in 2022 fall under the social category – COVID response & recovery, poverty reduction, and propelling actions on gender equality. The remaining two relate to climate change and conflicts.
- EU member states have unparalleled investment in social protection, 80% of workers in the EU have access to unemployment benefits – only 30% are potentially covered in the rest of the world.
- Community-driven development programs have been critical in providing social development in geographically remote and operationally hard-to-reach areas. As of June 2021, the World Bank supported 374 active Community Driven Development projects in 93 countries at a total cost of $42.6 billion.
The spotlight shone on such social issues means they are becoming increasingly more critical for corporations, investors, and regulators alike to address. Social issues can be observed through various lenses like employee engagement – community relations, diversity & inclusion, ethical supply chain practices, human rights, wage equity, and labor standards, to name a few.
While it might seem difficult to define and quantify social responsibility, such factors significantly influence trust, financial performance, and the overall value proposition of a business.
But the heightened attention to social dimensions does not make it easier to measure. And not surprising, social investing also receives less funding relative to the environmental element of the acronym. A 2019 Global ESG Survey by BNP Paribas revealed that 46% of investors surveyed (covering 347 institutions) found the social aspects to be the most difficult to analyze and embed in investment strategies. According to the report, investors understand the ‘E’ and the ‘G,’ but not the ‘S’ for various reasons.
Notwithstanding these challenges, the social dimension offers tremendous opportunities for the financial sector. Of the 17 Sustainable Development Goals enshrined by the United Nations, 11 are dedicated to social empowerment. To achieve the goals by the target date of 2030, an estimated $5-7 trillion of ‘S’ investment is needed per year – but only half of this is currently being spent.
This annual investment gap of $2-4 trillion presents a vast opportunity for the financial sector. For investors, this means bridging the financial gap by backing companies offering social goods and services.
Companies need to have their own house in order before they can be assessed on whether they are doing good for society.
Identifying Companies with a Strong Focus on Social
How can investors identify companies with a strong focus on social elements? The starting point is internal: companies need to have their own house in order before they can be assessed on whether they are doing good for society. If the internal culture is inclusive and diverse, employees are happier, and suppliers are treated fairly, we can expect a business to have healthy growth.
Investing through a social lens provides a strong opportunity to capture growth across sectors and allows investors to be part of the solution to the challenges created by inequality. Socially responsible investing (SRI) is when investors strategically invest in companies with ethical practices. The definition is broad, as ethical practices vary widely depending on who is evaluating them.
An example of an ethical practice might be using green technology, avoiding specific areas such as firearms and tobacco or investing in organizations embracing diversity and inclusion as well as investing in companies that ensure human rights aspects in their supply chain. Research shows that companies with a top-quartile approach to ethnic diversity and gender diversity were 36% and 25% more likely to have strong financial performance, respectively.
It is not just about ‘doing the right thing,’ it also makes financial sense as good companies doing good things for the world should increasingly see this reflected in their market value.
Strong financial performance ultimately drives strong share price. This is a compelling investment argument for prioritizing social issues. It is not just about ‘doing the right thing,’ it also makes financial sense as good companies doing good things for the world should increasingly see this reflected in their market value.
The proverb ‘it takes a village to raise a child’ sums up the notion that an entire community must contribute to ensuring a prosperous future. The S element of ESG applies this notion on a global scale. Ultimately it will require corporations, employees, suppliers, and all of society to contribute towards ensuring a better future for coming generations.
This article reflects the personal views of the author.
