The role of social factors in sustainable investing may be less intuitive than that of environmental or governance factors but it is no less crucial. Social issues, if left unaddressed, can have a detrimental impact on investment returns.
What are social factors and why are they important?
Social factors encompass a number of key risks faced by companies and investors. A company that doesn’t provide a safe and healthy working environment is less likely to have a happy and productive workforce, while a company that cuts corners on product safety, mis-sells products or has poor controls on data privacy risks serious reputational damage.
Take human capital management, for example. Particularly since the Covid-19 outbreak, companies appear to have taken a much keener interest in their employees’ health and wellbeing, providing cleaner and better-ventilated workplaces and offering additional healthcare benefits, including an increased focus on mental health. A company that puts human capital management at the forefront of its plans is likely to be better able to retain and develop its top talent—with clear advantages for its future performance.
Another key social factor is diversity, equity and inclusion. Creating a more equitable and inclusive workplace is something we firmly believe is important not only for cohesion within the workforce, but also in terms of creating value for investors over the long run, with research studies suggesting that having greater diversity at board level can be beneficial for a company’s financial returns.1
Crucially, social issues can arise all along the supply chain, with companies facing penalties if they deal with suppliers that treat their workers badly, or that are causing damage to the environment. And companies may face large fines, or litigation, if their operations are detrimental to local communities, due to issues such as pollution or poor resource management.
How are social issues identified?
Identifying social issues faced by companies has become easier thanks to the revolution in data. Fund managers with the capability to do so can now trawl through thousands of data sources to identify how social factors could have a real impact on sustainable outcomes, as well as companies’ future financial performance.
Once “S” issues have been identified, fund managers need to decide whether they can be addressed within a reasonable timescale, or whether the risk is too great. In the case of some issues such as the mis-use of customer information, it may take a very long time to recover from the reputational damage caused, highlighting the potential long-term consequences of poor social practices for businesses and the risk to investors of ignoring them.
Given the risks posed by social factors, investors are increasingly paying them closer attention. According to J.P. Morgan Asset Management’s 2022 Future Focus Survey, European investment advisers who have traditionally focused on the environmental side are increasingly also prioritising social issues2. This is a positive development, as taking social considerations into account alongside environmental concerns can help investors support more holistic sustainable solutions, such as providing support to communities that are currently reliant on carbon-intensive industries.
1 Delivering through diversity – McKinsey; January 2018.
2 2022 Future Focus Survey – J.P Morgan Asset Management; October 2022.