What's stopping investors from adding the 'S' to 'ESG'?
Anna Triponel
June 7, 2021
Our key takeaway: De-bunking misconceptions about integrating the “S” into ESG is a necessary step forward for investors. The next is ensuring that social indicators used by investors are meaningful.
The ESG Working Group—a cross-sector coalition of organisations, including The Thomson Reuters Foundation, Refinitiv, International Sustainable Finance Centre (ISFC), White & Case, Eco-Age, The Mekong Club, and the Principles for Responsible Investment (PRI)—have released a white paper to “address the most common misperceptions, or myths” that investors face “when trying to integrate social performance indicators into their analytical metrics.” Here’s what they’ve found:
Investors need to be aware of five fundamental “myths” about integrating the “S” into ESG. Myth 1: “Social performance is less financially material than environmental performance”; in reality, social issues can create high volatility and pose significant risks to the bottom line. Myth 2: “It is too difficult to know how and where to start assessing social performance”; in reality, not only is there a “well-established link” between business and human rights, but there are also a wealth of frameworks and tools for investors to get started. Myth 3: “’S’ indicators are too hard to measure [and lack] reliable and comparable data”; in reality, social indicators are becoming increasingly robust and well-defined (see the report’s Annex I for examples) and investors need to proactively “demand more data” to improve the pool. Myth 4: Social performance can only be captured by qualitative surveys and questionnaires; in reality, investors need to “use a combination of data-driven input and qualitative analysis for due diligence and engagement.” Myth 5: “Integrating “S” indicators is only relevant for impact investors”; in reality, social indicators are material to all types of investments and “can help to identify more resilient and profitable investment opportunities.”
Integrating data on social indicators into investment decisions improves resilience, de-risks investments and fulfils fiduciary duties. According to the white paper, “emerging evidence shows that the integration of ESG criteria in investment analysis leads to improved returns, less volatility and lower downside risk.” Integrating social factors, in particular, can help investors target investment opportunities that are both profitable and—crucially—“already aligned with established and anticipated regulation” like forthcoming EU mandatory due diligence laws. But caution is needed to ensure social indicators are meaningful: “Lessons learnt from the work of compliance professionals show that voluntary policies and procedural ‘tick-box’ exercises are not a remedy for avoiding enforcement actions or investment risks.”
“A proactive, mixed approach pays off”. The paper argues that investors need to combine qualitative and data-driven approaches to obtain better information about investments. Together, these approaches inform one another, create a more holistic picture of risks and opportunities, and ultimately “improve outcomes and help generate alpha.”
