How Investors Can Embrace the “S” in ESG
DATA ON COMPANIES’ SOCIAL METRICS MAY STILL BE INCOMPLETE, BUT THAT SHOULDN’T PREVENT INVESTORS FROM SCREENING BUSINESSES FOR LABOR AND HUMAN RIGHTS VIOLATIONS. THE KEY IS TO NOT LET THE PERFECT BE THE ENEMY OF THE GOOD.
Which company makes for a more socially-responsible investment: A car manufacturer that makes electric vehicles, or a coal company?
Investors hoping to find the answer in a column of data that flags companies and industries as socially-responsible may be disappointed to learn there is no “S” label that does that job for them. But maybe that’s a good thing, according to José E. Feliciano, co-founder and managing partner of Clearlake Capital.
“We need to be very, very careful about just putting the ESG label on a specific sector or removing it from a specific sector,” Feliciano said during a panel discussion about social performance metrics at the RFK Compass Spring Virtual Investor Summit in March.
A car manufacturer that’s sourcing lithium-ion batteries from a mine with a history of labor violations might not make for such a good investment, especially if the coal company it’s being compared to is embracing clean coal technologies that help limit carbon emissions, Feliciano explained.
Feliciano’s example underscores one of the core challenges facing investors looking to broaden their inclusion of social factors when analyzing companies’ environmental, social and governance (ESG) risks. Data on companies’ ESG metrics is still patchy and incomplete, making it harder for investors to do comparable assessments across companies or industries.
That shortage has been especially acute in the social categories of ESG analysis, which include labor rights, racial equity, economic inequality and other issues that are often hard to measure and quantify. But that scarcity is now changing—and that means more opportunities for investors to finally embrace social factors in ESG analysis.
One way in which data use has evolved is that investors no longer use social metrics merely as a negative screening tool when evaluating investments, according to David Craig, CEO of data provider Refinitiv and Group Head of Data & Analytics, LSEG. Instead of excluding companies involved in say tobacco or firearms or other questionable industries, investors may instead want to screen companies for actions they’re taking, like participation in worker-driven social responsibility programmes that provide farm workers with fair wages and decent working conditions or ESG R&D innovation.
The problem, though, is that the “S” in ESG “can mean many different things to different people,” Craig said. Disclosure of various social metrics depends on legal and regulatory requirements or whether companies care enough about particular social risks to provide them to their investors on a voluntary basis. As a trusted data provider, Refinitiv has worked for over 20 years in this area providing as many metrics as possible, some 450 in total, but few companies will report on all of them. “The goal is to provide investors with the most complete view possible,” Craig said.
The key, Feliciano explained, is to not “let the perfect be the enemy of the good.” That means using existing metrics and data sources to evaluate companies, prompt them to improve their business practices and ask for more data where needed. Refinitiv, for example, has launched a new initiative to encourage and allow companies to report race metrics so investors can get better insights into their workplace demographics.
Media reports can help investors fill in the gaps on their understanding of companies’ social metrics. In 2016, for example, the Thomson Reuters Foundation published an investigation into the use of child labor in India’s mica mining industry, where children’s deaths in unregulated, crumbling mines were being covered-up by mine operators. The exposé linked the dangerous mines with supply chains that reached German carmaker Volkswagen, which stopped buying mica from some suppliers in India as a result of the Foundation’s investigation.
“The role of the media is really crucial in raising awareness of infringements on human rights,” said Antonio Zappulla, CEO of the Thomson Reuters Foundation.
Livia Firth, co-founder and creative director of integrated sustainability consultancy agency Eco-Age, pointed out that today, thanks to social media, information about companies’ violation of human rights travels faster than ever before. She pointed to the speed with which news spread of slave labor in China’s Xinjiang province, and the implications it has for major clothing brands that source cotton from the region. That makes it more important than ever for investors to embrace the “S” in ESG.
“It’s not anymore a moral issue. It’s an investment issue, as the question here is: ‘is it really worth it to invest in a business that has no future?’” she asked. “The answer is ‘no.’”