a guide to exploring esg
in partnership with
E
s
G
social
environmental
governance
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What ‘social’ factors impact companies and why does it matter?
How to define and measure ‘social’
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Insight from the UN Capital Development Fund
The ‘S’ approach for ESG investments
A look at why investing in ESG doesn’t mean missing out on investment opportunities
Dispelling the myth
Examples of good social practices from companies in sectors such as healthcare
Emma Doner, ESG analyst at Capital Group, highlights some of the key social themes investors should be aware of
Analysing the trends
Social in action
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a guide to exploring esg: social
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What ‘Social’ factors impact listed companies and why does it matter?
The ‘social’ element of ESG can be less obvious than its ‘environmental’ and ‘governance’ counterparts and advancements in policy tend to be slower than those focused on climate change, for example. Yet, it relates to the very glue that holds business models and the economy together – the people. When assessing the social considerations of a company the following may be factors: diversity policies across the workforce, board and senior leadership, the health and wellbeing of staff across the supply chain, internal human resources, human rights, the way people work (flexible working, for example), corporate culture (which can also overlap with ‘Governance’) and cybersecurity or privacy. Social concerns have been elevated in the context of the pandemic – investors have questioned the health and wellbeing of staff and whether there are equal opportunities for all. These include: How many employees have been furloughed (staff who have had their wages subsided by governments for a set period during the pandemic and local lockdowns)? Are senior management sharing the pain? Are employees being well-protected from the virus in their workplace and what about clients and customers?
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global aum in sustainable funds in Q1 2021
$2trn
Social concerns have been elevated in the context of the pandemic – investors have questioned the health and wellbeing of staff and whether there are equal opportunities for all
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A 2019 Global ESG Survey of 347 institutions by a leading European bank revealed that 46% of investors surveyed found the ‘S’ to be the most difficult to analyse and embed in investment strategies
year-on-year increase, as at july 2021
17.8%
sustainable funds net inflows , Q1 2021
$185.3bn
Many investors want to see a ‘just transition’ as we move closer to a more sustainable economy. The concept of ‘just transition’ was identified in the Paris Agreement in 2015 and seeks to ensure that the benefits of shifting to a green economy are shared widely, while supporting those who stand to lose economically – be they countries, regions, industries, communities, workers or consumers. In addition, there have been increasing initiatives from corporates to create inclusive, diverse, and equitable workforces over recent years – with a focus on gender, race, ethnicity and sexuality – as gaps in diverse representation and benefits of inclusive cultures become better understood. The social element can be the most challenging for investors to assess and measure. A 2019 Global ESG Survey of 347 institutions by a leading European bank revealed that 46% of investors surveyed found the ‘S’ to be the most difficult to analyse and embed in investment strategies.
As social considerations are often looked at in terms of their impact, investors could also use existing ‘impact investing’ frameworks as references. These include those from the Global Steering Group for Impact Investment (which aims to improve the lives of billions of people in informal settlements and improve access to capital for businesses in these areas) and the Impact Reporting and Investment Standards. Big Issue Invest, is an example of this type of investment approach. One of its investees, East Lancashire Moneyline, lends at affordable rates to low-income people who might otherwise turn to high cost ‘doorstep’ or ‘payday’ lenders. It’s likely that clearer ways to measure social considerations will follow and evolve over the next few years. The concerns around the Covid-19 pandemic are not going away, keeping the human element of corporate activities at the forefront of investors’ minds. In this environment asset managers who are acting as stewards on behalf of their investors are talking more and more about a ‘just transition’. It looks as though the social element of ESG will continue to pique responsible investors’ interest going forward.
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1 A green economy is defined as low carbon, resource efficient and socially inclusive.
2 Impact investing is investing with the intention to generate positive, measurable social and environmental impact alongside a financial return.
3 Informal settlements are areas where groups of housing units have been constructed on land that the occupants have no legal claim to or areas where housing is not in compliance with current planning and building regulations, such as slums or shanty towns.
The concept of ‘just transition’ was identified in the Paris Agreement in 2015
There are a lack of frameworks for presenting ‘Social’ data and information, and those that do exist tend to be focused on just one area. Many countries require modern day slavery reporting and gender pay gap reporting but there is little consensus on how to measure and assess a company’s overall social impact objectively. There are some tools available: investors are encouraged to assess social considerations through a number of lenses including the UN’s Sustainable Development Goals (which include targets on poverty and access to education, for example). Capital Group are signatories to this initiative with a focus on the development, implementation and disclosure of responsible business practices. Other approaches include the World Economic Forum’s guidelines on social justice and equitable systems and Global Reporting Initiative’s standards, which touch upon occupational health and safety.
The SDGs – Your comprehensive guide to the ‘S’ approach for ESG investments
Within ESG it is commonly acknowledged that an investment’s key approach is more easily determined against ‘E’ and ‘G’ factors. Social factors – the ‘S’ – can be harder to quantify and measure. For ‘impact investors’, who aim to generate beneficial social or environmental effects in addition to financial gains, this triggers two critical questions. What kinds of projects deliver social return on investment and how can they be reliably identified? The answers to both questions lie in the UN’s Sustainable Development Goals or the SDGs. The SDGs are largely understood to be a roadmap for those in the development space (governments, multi-lateral organizations, non-governmental organizations, development finance institutions) to achieve sustainable development; striving for such goals as the elimination of extreme poverty (SDG 1), scaling global food security (SDG 2), ensuring all girls and boys complete quality primary and second education (SDG 3); and ending all forms of legal discrimination against women (SDG 5).
The SDGs also represent a powerful, credible investment roadmap, a roadmap that can support a market for investments that advance sustainable development
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But the SDGs also represent a powerful, credible investment roadmap, a roadmap that can support a market for investments that advance sustainable development—from supporting clean energy and combating climate change (SDG 7 and SDG 13), to advancing innovation and infrastructure (SDG 9), to making sustainable cities and communities (SDG 11). Through a common set of development priorities, the SDGs create a global framework for future development projects. This framework will both attract finance from development organisations and encourage commercial finance from investors, including impact investors with social goals. Concerns regarding lack of standards and the prospect of “green-washing” are prominent discussions in the investment industry today, the SDGs provide a well-defined framework to combat this. It would be easy to dismiss the SDGs as an authoritative standard for impact investment if one focused solely on the SDGs’ 17 distinct goals. But the success of the SDGs will be comprehensively measured on the basis of 28 targets and 169 indicators. If you are looking for a clear matrix of what social means in the context of an investment, the SDGs provide quantifiable clarity.
Since the launch of the SDGs in 2015, the world has been given a platform to advance sustainable development
The success of the SDGs will be comprehensively measured on the basis of 28 targets and 169 indicators
The lack of inclusive policies and inclusive regulations is a fundamental reason why women in these markets are unable to access financing that can enable them to achieve financial agency. Often local policies, laws and social norms are discriminatory. Local fiscal policies and systems of governance are often gender-blind, defined by a lack of women’s leadership in decision-making. The lack of such policies is also a fundamental reason why the full power of digital cannot be leveraged to scale financial services. A dearth of appropriate regulations and policies in such areas as e-payments, know-your-customer regulations, and policies around anti-money laundering and countering the financing of terrorism regularly result in frictions that prevent finance from reaching the areas that need it the most. Finally, the lack of inclusive policies and inclusive regulations results in under-financing of the critical driver of basic services: cities and local governments. Fiscal or government resources and domestic capital markets (banks, institutions and other investors) are not investing in local governments and local economies in ways that promotes sustainable and equitable growth, which is holding back structural transformation and economic resilience.
Core effort
The confidence to pursue an SDG-positive investment — an investment that advances SDG achievement, as opposed to simply reducing potential negative factors — is determined just as much by the platform of the investment as by the investment itself. The UN Capital Development Fund (UNCDF) — the UN’s flagship financing agency for many of the world’s frontier markets — is actively involved in platforms that enable investors to discover, investigate and finance projects that possess the potential for commercial return and social benefit. One platform that is closely aligned to its mission is the International Municipal Investment Fund (IMIF). The IMIF is a unique, bespoke investment fund designed to invest in locally-sponsored, commercially bankable infrastructure projects that will accelerate SDG achievement. It will seek investments in the transport, utilities, clean energy, waste management, land use and city planning sectors amongst others.
Another platform that is aligned to its mission is the BUILD Fund; a blended finance vehicle designed to attract concessional (loans offered at lower interest rate) , semi-commercial and select commercial growth finance to UNCDF’s pipeline of small and medium enterprises (SMEs), financial service providers, and local infrastructure projects. Through the BUILD Fund, the UNCDF aims to capitalize the financing gap that affects entrepreneurs in frontier markets where growth is constrained by a lack of access to follow-on financing. Follow on financing is where a business seeks additional funding to achieve its goals. To the point, the BUILD Fund is one of the few investment funds in the impact investing market with a specific focus on frontier markets. Since the launch of the SDGs in 2015, the world has been given a platform to advance sustainable development. With the SDGs becoming more recognized over this time, it can now serve as an index for the kind of social-impact investments that can turn commercial finance into a force for humanity.
1 Concessional finance should be used for projects that contribute significantly to market development. This generally means that the financing will help overcome a market failure and provide returns to society beyond the investors' returns.
Do investors have to give up returns when investing in companies with good ESG credentials?
One of the myths that has surrounded ESG investing is that while it might make investors feel good it comes with one major sacrifice: potentially weaker investment performance. Based on the notion that ESG-minded managers have a smaller investment universe compared with their non-ESG peers, there has been concern that excluding companies and sectors that don’t adhere to an ESG agenda would mean that funds miss out on potential sources of investment returns. However, a look back at the last three years seems to go some way to dispel this myth. Indeed, rather than to its detriment as the old myth suggested, Capital Group believes that integrating ESG into its investment process will lead to better outcomes for its investors and the organisation as a whole. “There are lots of different ways to measure ESG performance and there have been many academic studies carried out, but the heart of ESG is focusing on what is material,” says Emma Doner, ESG analyst at Capital Group.
initial fall of ftse 100 after lockdown
-30%
recovery during past month
+20%
netflix
AMAZON
+25%
microsoft
+44%
Capital Group believes that integrating ESG into its investment process will lead to better outcomes for its investors and the organisation as a whole
Today in the US, across the S&P 500 about 90% of companies publish a sustainability report, while in Europe sustainability reporting is mandatory for most companies
Doner says Capital Group’s experience and research indicate that when an organisation takes a thoughtful and robust approach to ESG, it can be a positive indicator of sustainability and strategic thinking. As a result, it is their belief this approach will eventually be reflected in a company’s share price or an organisation’s trajectory. For example, when considering the social element of ESG, Doner says what is important is to simply think about people. Namely how does a company interact with its employees, how does it interact with its supply chain and how does it interact with its consumers and what is the impact of its products and services on them? “All of these things are integral to a company’s success and if one of these relationships breaks down it would quickly become in trouble,” she said. “So, when you simply focus on the things that are material these things should go hand-in-hand, not in opposite directions." So how does Capital Group go about measuring a company’s ‘social impact’? Doner says while there is not a one-size-fits-all approach, one trend they are noting is the availability of more ESG data which is proving helpful to investing.
“Today in the US, across the S&P 500 about 90% of companies publish a sustainability report, while in Europe sustainability reporting is mandatory for most companies,” she says. “While not all of the indicators and information they provide to investors is standardised, repeatable or comparable, it does give us a solid foundation.” However, she adds that while there is plentiful data to measure things like employee turnover rates, personnel costs and the type of benefits provided by a company, there are areas where data is less available, such as racial equality, diversity and inclusion. “Last year we did a lot of research that looked into how companies that are more diverse and more inclusive actually have better business results,” she says. “Intuitively this makes sense, but there is now growing evidence that diversity helps business resiliency, productivity and innovation and it is something we have consistently been incorporating into how we invest."
Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. The information provided is not intended to be comprehensive or to provide advice.
How do investment groups analyse the social elements of companies?
The ‘S’, namely the social element of ESG, may seem harder to define and some of the issues related to it softer, but it can have a massive effect on a business. As a way of illustrating the importance of the ‘S’ let us start by looking at a part of the economy which was clearly affected by the pandemic, namely restaurants. Covid-19 added considerable risks to the restaurant industry, one of which was to keep employees safe while returning to work. Health and safety has always been an important consideration for restaurants, but Covid-19 pushed it to the forefront. Companies that placed a high value on ‘S’ factors were required to rethink how to protect employees and incentivise them to stay home if they were at risk of infection, while supporting overall well-being through wage stability and benefits like access to healthcare (including mental health), and childcare where possible. We spoke with Capital Group, one of the world’s largest equity and fixed income investors, to see how the firm analyses the ‘S’ (Social) as part of its wider research into companies.
Companies that placed a high value on ‘S’ factors were required to rethink how to protect employees
Investment opportunities are identified through this deep, fundamental, first-hand research
Zeroing in on material issues
Capital Group describes its approach to ESG as comprehensive and evidence-based. The firm’s analysts identify social topics as being the most material ESG issues within healthcare services. These include a focus on consumer safety, product quality, affordability and access, data security and privacy, all underpinned by strong management quality and accountability. When evaluating the ESG issues within the US healthcare services sector, Capital Group analysts look to identify those they believed could be most material to the success of a company as a long-term investment. In US healthcare services, one key thesis is that value-based care – which incentivises keeping people healthy over additional fees for services – is the most sustainable model over the long term. Doctors in these ‘value-based care models’ tend to conduct more proactive patient outreach, preventive care and ongoing patient healthcare monitoring. Capital Group’s analysts believe this approach helps raise the health of the broader population, and in turn likely saves costs and increases patient satisfaction and retention.
To evaluate a company against this investment backdrop, the analysts conduct primary research through dialogue with the company itself. They ask questions directly to people at all levels of management, not just the senior leadership. This helps the analysts to understand if the stated priorities are clearly evident in the company’s culture and operations. Importantly they don’t ask just once — or even once a year. It’s an ongoing and continuous process. Beyond dialogue with companies, the analysts look at indicators such as customer satisfaction tracking and net promoter scores. They also review and assess the risk of sanctions from regulators, including warning letters, fines, restrictions and recalls. The challenge lies in determining which issues might be material to a company and gauging the time frame over which that could be reflected in share prices. Investment opportunities are identified through this deep, fundamental, first-hand research. This proprietary analysis of companies often means the Capital Group analysts may have a different opinion from independent ESG research groups: ‘we don’t outsource fundamental research, and we don’t outsource our thinking on ESG.’ Says Matt Lanstone.
For more information go to ESG Clarity. To read more about ESG at Capital Group click here.
a guide to exploring esg: Social
