This key element of ESG investing could drive real change at companies and increase returns
A pedestrian walks past the Wall Street subway station near the New York Stock Exchange (NYSE) in New York, U.S., on Monday, June 27, 2022. Money managers who bet on next -stable global turn left very disappointed in the second half of this year crushed as a long emerging bear market, even if inflation is found. Photographer: Michael Nagle/Bloomberg via Getty Images
Bloomberg | Bloomberg | Getty Images
With the importance of socially responsible investment strategies becoming increasingly ubiquitous, advocates are turning their attention to an area they see as less understood.
The social pillar of the environmental, social and corporate governance investment framework – known as ESG for short – has been called the “middle child” largely due to data challenges. As ESG has reached new heights of widespread awareness on Wall Street and Main Street, those in the space now see an opportunity to better define and measure the “S” column.
“There’s been some growth,” said Michael Young, director of education and programs at the Sustainable Institution Forum. “But among the three, it is definitely the most recent type to be included in the investment process. And not everyone will use it in the same way.”
For years, the social column has been considered to be somewhat vague and difficult to measure. BNP Paribas found in 2021 that more than half of the 350 global institutional investors surveyed believed that the “S” was the most difficult to analyze and integrate.
At the same time, the climate and corporate leadership topics have raised interest. That came in part because climate change and racial justice have gained more attention in recent years, pushing investors and company leadership to pay more attention to how corporations perform in these areas. And it comes despite the fact that the ESG investment framework has found itself in hot water politically.
Now, investors are left trying to understand what the “S” means to them and the best way to analyze corporate efforts in the space.
Defining and Measuring the ‘S’
The elevator pitch definition for the social pillar usually goes something like this: This is how companies interact with their communities, both in terms of their work forces and the places in which the their business works.
Although data on human capital and diversity has improved over the past several years, investment professionals still see a lack of standardized information that can make social topics more difficult to integrate. The data operation can also provide apples-to-apples comparisons between competing companies.
Looking ahead, Young said advocates are monitoring the human capital disclosure rule from the Securities and Exchange Commission. They hope that the rule will lead to a database of information from companies given to the Equal Employment Opportunity Commission that will be available to the public.
“That would be a big boost,” he said. “This is the first ‘S’ publication rule in the United States. “
Without enough standardized data, some have gotten creative.
Marian Macindoe, head of ESG stewardship at Parnassus Investments, said data on the proportion of part-time versus full-time workers, benefits for contract workers and evidence of hiring best practices are all in their things to consider. She said that Parnassus often requests contact data from companies, while admitting that it is an imperfect way to measure performance.
When looking for information about a company, her team will search for public fines or lawsuits against a company. Even reviews on Glassdoor or memes posted to social media platforms that touch on common topics can offer consumer insights, she said.
The company wants companies to know: “This stuff is important – and you should be responsible for it,” she said.
Harbor Capital and Irrational Capital are partnering to build exchange-traded funds thematically based on employee satisfaction: They include the Harbor Capital Factor US Large Cap ETF and the Harbor Corporate Culture Small Cap ETF .
Conveniently, the currency trades under several tickers — such as HAPI and HAPS — that use the same first three letters as the word “happy.”
The large cap vs small cap fund this year
The fund uses data collected by Irrational of more than 15 million employees across several thousand companies. That’s useful because the company believes that strong employer-employee relationships can drive better business performance and, therefore, increase dividends.
Big tech names like Microsoft, Apple, Alphabet and Meta some of the largest positions in the large-cap fund since mid-November. At the same time, Success, HB Fuller, Apple hospitality and Evercore among the biggest holdings in the small-cap draft.
Elsewhere, socially responsible investors see companies’ roles in the communities in which they operate as part of the “S.” Macindoe said companies can sometimes mistake this for simply doing charity work rather than being active members of the community.
“Charitable and philanthropic giving is great, but that’s not the ‘S’ of ESG,” she said. “The ‘S’ in ESG is about taking care of the people who depend on you and whom you trust when planning your business strategy and operations.
There can also be overlap between environmental and social issues that can sometimes cause confusion, according to Yijia Chen, vice president at Calvert Research and Management, a firm that was an early supporter of investment by social responsibility. In these cases, she said that the social pillar comes in to ensure that carbon transfer is fair and equitable.
Globally, social themes are likely to become clearer and more important to investors over time.
This year, BNP Paribas found investors around the world said that a company’s commitment to employee issues would be a greater priority when voting a proxy or making investment decisions in the next two years. (BNP Paribas specifically measured topics such as fair pay and equal treatment. The company also asked how investors see the importance of a company increasing diversity, equity and in- take, abbreviated as DEI, in the workplace.)
But North American investors showed a reversal, with the survey finding that these issues will lose priority over the next two years. That comes because ESG and DEI have become politically involved and have encouraged debate among lawmakers over the past year.
At the same time, back towards Target‘s Pride gathering and Anheuser-BuschA Bud Light campaign featuring a transgender influencer has become a symbol of how the so-called culture wars have infiltrated corporate America. RBC Capital Markets found that US corporations have increasingly turned to terms like sustainability rather than ESG when discussing social responsibility on earnings releases.
While the ESG landscape has become politically charged, some investors are warning against reactive moves such as divestment when they don’t see a company living up to values with social responsibility.
Instead, they argue that they can have a better impact by using their power as activist investors to advocate for better policies. Many point to relevance and risk reduction as reasons they repeatedly present to companies as to why they should be concerned about ESG issues.
Han Yik, senior pension consultant for the New York State Teachers Retirement System, told ESG conference attendees last month to think of the decision to withdraw as which they treat waste in a backyard. The trash can be moved to a neighbor’s yard, or it can be dealt with for the betterment of all.
“We don’t like demerit,” Yik said. “We think we can have more impact as owners of companies than if we sell them to someone else.”
Although ESG experts struggle with data challenges and wider confusion about the social pillar, they say its importance should not be a very hard sell.
“If you’re a business and you don’t take care of the natural human capital that your business depends on, you’re not going to be successful in the long run,” McIntosh said. “It’s just about scanning your landscape and making sure you’re going to succeed in it for the long term.”