Advisory Intelligence: The importance of the ‘S’ in ESG
ESG related issues have for some time been the political zeitgeist which have slowly seeped into the economic sphere, making it one of the most fascinating points of focus and development in the investment arena.
Though when ESG is split into its component parts: the ‘E’ – the environment has dominated the narrative, with the ‘G’ – governance – being the bread and butter issue companies must be seen to be dealing with effectively, while the social aspect, making up the ‘S’ has been left behind like Kevin in Home Alone.
This however is changing. Elena Basova, senior analyst, at Nasdaq, says there has been a shift in the narrative of the ‘S’ in the ESG, which has typically been used by companies for good PR to trot out when some social or philanthropic deed has been undertaken.
‘The corporate community, regulatory bodies and academic community are now exploring the juxtaposition of ESG and long-term economic success of corporate companies. Therefore the social aspect of ESG is no longer just about philanthropic metrics.’
It turn, this means the ‘S’ now impacts a variety of metrics utilized in the investor’s assessment of the corporate’s long-term performance. ‘Sustainability of performance is one of the primary concerns to investors – who now have to get creative in their ways of assessing it,’ notes Basova.
This comes down to so-called intangible asset creation, which has been an increasing focus of economic innovation in recent years and is only going to increase going forward. Basova explains: ‘An increasing amount of intangible items on the balance sheet, such as brand value, customer loyalty etc are metrics hard to quantify for investors. So they have to get creative and dive into the social aspect to be able to determine the value of the investment in front of them. So the approach is no longer just quant orientated but is leading to a more qualitative evaluation.’
Adding to the mix are societal challenges and changes, with the importance of social media and debates around fake news. ‘We are moving into a world where it is difficult to quantify things anymore,’ notes Basova.
This presents an obvious challenge to the IRO. ‘We recommend IROs report definitions on certain metrics within ESG as they – the ESG issues – are the ones being discussed the most,’ advises Basova.
But there is also an impetus for the IRO to work across the business to present a more solidified message on the issue of ESG. ‘There is a lot of disconnect between the IR department, the corporate secretary and the governance function, or whoever they have in place dealing with these issues,’ notes Basova. ‘So it is about bringing them all together and seeing what can be done from an IRO perspective about how best to communicate the message to those investors who care about these issues.’
In addition, with a huge surge in passive investment this has led to a lot of risk for passive managers. Because although they manage much capital, crucially they cannot divest like an active manger would. Meaning in turn they have long holding periods with passives tied to longer term investments like pension funds and endowments.
‘So they [passives] are going back to the social aspects and trying to influence companies to make sure that their metrics are social – as it impacts on the long-term performance,’ observes Basova. And as many of the leading passive managers are major investment behemoths they are likely to be successful in changing the social measurement metrics for the better.
Within this picture, IROs have a fruitful part to play. ‘IROs should proactively and regularly reach out to passive investors who care about social and ESG issues as this can play out favorably during proxy situations,’ notes Basova.
And for corporates the big point of focus should be human capital. Blackrock Institutional has been spearheading the connection between ESG – particularly the ‘S’ aspect of it and sustainability of return – in particular, with the human capital aspect of the ‘S’ gaining additional attention as a result.
Basova adds ‘There is a need for companies to report on the human capital element and that means diversity, equal opportunity, health and safety, labor relations and supply chain management. That is what they should concentrate on.’ In this way, Basova concludes: ‘ESG has a real world application for social and business benefit.’