The silent S in ESG

E, S and G – how often do you think about these three letters? Once a week? Twice? Every day!?

Imagine an investment professional who went on a silent retreat in the middle of nowhere five years ago and came back today. Apart from being slightly confused about why everyone is wearing masks and hoarding toilet roll, I think one of her biggest surprises would be to see how much we, as an industry, now talk about ESG.

So, what does it actually mean?

The E stands for environmental – it covers climate change, biodiversity and more – and we’ve seen a lot of progress in this area, especially with the new Task Force for Climate-related Financial Disclosures and its sister framework, the Task Force for Nature-related Financial Disclosures which is due for completion in around 2023.

The G stands for governance – it encompasses how businesses and companies run themselves, how they are structured and their decision-making processes.

But what about the S?

When we think about our investments, we don’t usually think about social issues – but we may be surprised to find out what goes on under the bonnet of our investments if we lift the lid up and examine them. There are a vast number of social issues to deal with, many of which overlap with other risk factors, but here are just a couple of them:

Just Transition

A ‘just transition’ is an approach to decarbonising the economy that ensures that workers’ rights and livelihoods remain secure as society shifts to a more ‘green economy’.

Now hold on a minute, isn’t this blog supposed to be about social issues? Why am I mentioning words like ‘green’ and ‘decarbonising’ – aren’t those words to do with climate risk and the environment?!

Well yes, they are – but like a lot of things in life, climate risk does not exist in a self-contained silo.

Moving to a greener economy has implications for society as a whole, and that it why it is imperative to consider climate risk not just through the lens of the environment, but also through the lens of wider society.

In France, there have been multiple ‘Gilets Jaunes’ protests as part of a movement for economic justice. People felt that policies meant to address climate change were having a disproportionate tax burden on the working classes, especially in rural areas. For example, people in these areas needed fuel to travel to their workplaces, and increased sales tax on fuel would make it difficult for them to afford to travel to work.

These protests ultimately resulted in riots and lockdowns, which had a huge impact on the French economy and slowed down the transition to a low carbon economy.

Modern slavery

Slave labour can take many forms – including forced labour, prison labour and trafficking. Technically speaking, many companies have clear policies against modern slavery.

But below the surface, many mainstream, publicly traded companies, rely on slave labour within their supply chains.

When the news comes out about companies using slave labour in their supply chains, it can have a huge reputational impact which can manifest in their value falling. You may be exposed to this financial risk if you are invested in companies with exposure to modern slavery – many index trackers will have exposure.

Using our ESG dashboard, we can help you identify holdings in your portfolio that negatively contribute to your portfolio’s MSCI social scoring. This can help you engage with your managers to understand whether they are addressing these issues adequately.

What are the regulators saying?

We are seeing the S in ESG get a lot more scrutiny from regulators and campaigners.

The Department of Work and Pensions recently issued a call for evidence on how pension schemes in the UK are addressing social issues. The expectation is that the responses will reveal that positions on social factors in investment policies and Statements of Investment Principles are relatively rare – and this is probably due to the practical difficulties of understanding and managing social risks.

In addition to this, the Pensions Policy Institute recently published a paper entitled ‘Engaging with ESG: Climate Change’ which stressed how important social risks are expected to be over the next few years. The paper described how social risks can be harder to quantify and measure, which is why they may have historically taken a back seat to some other responsible investment factors, but that does not make them any less important financially or ethically.

What can we do to start addressing social risks in our investments?

A great first step is to start asking your investment managers about how they consider and manage social risk, and whether they incorporate social risks into their climate change policies.

Another thing you can do is invest in products that are specifically designed to have a positive impact on society (as well as deliver a financial return).

Some examples of these are social bonds, social housing, microfinance and impact equity investing. We research a number of different products and funds in this area which we can provide guidance on.

We are also an influencer for Pensions for Purpose, a collaborative initiative of impact managers, pension funds, social enterprises and others involved or interested in impact investment. This organisation has created a lot of great resources for impact-related investments – in particular, it has worked with ‘Impact Invest’ to create a useful set of five principles for pension scheme investors to consider. One of the key recommendations of these principles is to identify and appoint investment consultants who are aligned with your investment beliefs and objectives, and investment managers who can achieve your scheme’s impact objectives through their investment and stewardship activities.

Another great way to assess the positive social impact of your investments is by using our ESG Impact dashboard, which gives an idea of the proportion of portfolio revenues that are a result of social (and environmental) impact products.

Example corporate bond fund

Asset class: Corporate bondsComparator index: Example corporate bond indexSource: Certain information ©2020 MSCI ESG Research LLC. Reproduced by permission. Fund and index weight holdings as at 31 Mar 2020. Other data as held on the MSCI database at 23 Jul 2020.*

The S in ESG is no longer silent

This is an area that is going to get a lot more scrutiny from society and from regulators in the near future, which is why we think it’s a really important issue for all investors.

It can be overwhelming to start thinking about social risks within your investments – there are so many types and many of these risks are difficult to quantify and address. But just because these risks may be difficult to understand, it doesn’t make them any less important.

For more information on any of the topics referred to in this blog, please get in touch with our Responsible Investment Team.

*Coverage: Holdings representing 64%, 66% and 66% of the fund value respectively have ESG scores, emissions intensity data and controversies assessments in the MSCI database. The corresponding figures for the Index are 91%, 87% and 89%. Coverage for individual metrics can be lower.