Why investors can’t overlook the “S” in ESG

Investors are increasingly being asked by their clients to deploy capital more responsibly. The increase in the assets under management in the ESG (environment, social, governance) space over the last several years reflects this.

The focus on achieving net zero greenhouse gas emissions and the increased need for renewable energy sources are just two of the drivers fuelling the growth of capital deployed in the “E” bucket within ”ESG”. But what about the “S”?

Despite heightened attention, the “S” in ESG has received less funding relative to the “E”. There are of course reasons for this disparity in funding, such as the inconsistency in the different methods of reporting social-based impact data, as well as lack of consensus on which social issues to include for assessment.

Many investors looking to deploy their capital in a socially responsible way will focus on companies whose products and services provide clear benefits to society.

The United Nations’ Sustainable Development Goals (“SDGs”) is a universal call to action to end poverty, protect the planet and ensure that all people enjoy inclusion, peace and prosperity. Of the 17 SDGs, at least 75% are focused on addressing improvements in society. We believe this is a useful tool for investors to assess a company’s qualitative societal impact.

Supply chain bottlenecks pose a risk

The current global supply chain disruptions are likely to draw attention to the social issues within companies’ supply chains, particularly as efforts grow to improve working conditions amid labour shortages.

Until now, companies have adopted voluntary international reporting and due diligence standards. However, there is growing evidence of an increasing global regulatory emphasis on corporate responsibility. New and prospective laws within the EU, its member states and other non-EU countries, for example, are now focusing on introducing mandatory ESG due diligence requirements for companies.

These requirements are aimed at ensuring measures are taken to prevent and address adverse impacts on human rights, while ensuring good governance is occurring in supply chains and business relationships.

This poses a risk for companies, especially those with an international footprint. Addressing any potential weaknesses at the earliest opportunity could help to avert future scandals, thereby avoiding reputational damage and reduced investor confidence.

How to improve “S” efforts

Not all companies operate in fields that have a direct link to the SDGs. For companies whose products and services may not be directly aligned to an SDG, we believe that management teams could consider the following measures to improve their “S”efforts:

• consider what the firm stands for and adopt a business code of ethics;
• create Employee Resource Groups aimed at promoting inclusivity across the organisation;
• provide employees with volunteering days to give back to the community;
• find organisations to work with to tackle issues that matter to customers. Set aside a proportion of the annual budget to fund charitable efforts.

While the above list is not exhaustive, it can help guide companies, particularly small and medium-sized enterprises, in the right direction. Investors can work actively to engage with companies to drive positive societal outcomes, and use their proxy voting power to veto against management teams and boards that fail to meet their commitments or goals.