Why the ‘S’ in ESG matters and how schemes can better understand it

Social issues have increasingly crept into focus in the past couple of years, as the Covid-19 pandemic has helped to highlight injustices and inequalities within society.

With pension schemes obliged to consider ESG factors when making investment decisions, it is crucial the hard-to-define social aspect is not cast aside. Unlike with environmental issues — which can be calculated — social factors are trickier to measure, says BlackRock’s head of UK Local Government Pension Scheme Gavin Lewis.

“The social aspect of ESG investment is often the most challenging in terms of measurement, as it contains numerous qualitative components and it also interacts with various macro-trends and differing societal expectations,” he says.

Ultimately, the ability to take an enhanced or more proactive approach towards social factors depends on better and more consistent disclosures from investee companies

Gavin Lewis, BlackRock

However, he adds that pension schemes can measure elements of companies’ social performance by their disclosure and action regarding issues and impacts that are within their control.

“Companies are more likely to meet their strategic objectives and deliver long-term value for their shareholders when they build strong relationships with their key stakeholders.

“Pension schemes can therefore measure the social performance of companies based on elements such as the action they are taking to support and protect the rights of their workforce, as well as whether they are fostering strong relationships with their customers and communities,” Lewis notes.

Schemes and trustees should expect companies to provide sufficient evidence of board oversight, due diligence and remediation of adverse social impacts arising from their business practices, he continues, adding: “Ultimately, the ability to take an enhanced or more proactive approach towards social factors depends on better and more consistent disclosures from investee companies.”

Make use of data

Despite the challenge of measuring social practices, there are tools that can assist pension schemes with their analysis of how a company’s social impact measures up.  

Xavier Desmadryl, HSBC Asset Management’s global head of ESG research, says data is increasingly being built up on social assessments of companies, either via companies or from data vendors, which pension schemes can then make use of.

“Reporting on E, S and G dimensions is no longer a good practice, it’s becoming the new normal, especially in developed countries,” Desmadryl notes.

“This has led to the emergence of legal frameworks in countries like the UK, France, broader EU or the US. This means that asset managers can easily access this publicly available information through scanning companies’ corporate social responsibility reports.”

Additionally, he says ESG data vendors can provide a wealth of qualitative and/or quantitative data that allows for a good understanding and assessment of companies’ broad ESG performance.

“Data like lost time injury rates, number of casualties per 1,000 employees, hours of learning and training per 1,000 employees are valuable ratios enabling comparisons between players unbiased by the company’s size — which are very helpful when it comes to building a buy list or dealing with arbitrages,” he continues.

“Then, more qualitative inputs such as the existence of policies, or the review and analysis of employees’ related controversies, help to frame an overall judgment.”

There is also a role artificial intelligence can play in helping to retrieve some unofficially disclosed information through scanning information sources such as social media or non-profit organisations’ websites.

“In turn, this helps in forming some ‘sentiment analysis’, unbiased by the company itself or by a third party’s subjectivity, in order to form a true and fair view of the company’s actual achievements,” Desmadryl adds.

Spotting long-term opportunities

As with other aspects of ESG, social factors can be used to spot long-term opportunities that pension schemes can take advantage of.

Nina Roth, BMO Global Asset Management’s director of responsible investment, says investors should be “active participants” in investor networks and stakeholder groups.

Roth argues this can help them benefit from diverse perspectives on any social theme, such as the living wage and diversity, to identify corporate leaders that might have innovative programmes or market-leading initiatives in their fields.

“Structured and strategic regulatory development monitoring, such as the EU Social Taxonomy, will also help to understand where future investments might be channelled and where further innovation is needed,” she adds.

Meanwhile, Big Society Capital chief executive Stephen Muers believes Covid-19 could provide investors with an opportunity to be at the heart of tackling social issues.

“Many UK social issues have worsened due to the pandemic, requiring large amounts of funding to be sought,” he says.

“The UK 2070 Commission estimates that the UK government’s ‘levelling up’ plans carry a £1tn price tag, while in the area of homelessness and rough sleeping, crisis data shows the cost of ending homelessness by 2041 is over £19bn.

“The increased need presents an opportunity for investment approaches offering genuine solutions,” Muers continues.

“Big Society Capital has supported a range of funds tackling critical social issues over the past 10 years. This includes the Greater Manchester Homes Partnership, which is supported and funded by Bridges Fund Management and has tackled Manchester’s homelessness crisis through housing 90 per cent more people at risk of homelessness than originally anticipated.”