Why the “S” in ESG Is Getting Attention

“ENVIRONMENTAL, SOCIAL AND GOVERNANCE (ESG) issues have historically formed a solid framework for those interested in sustainable and impact investing,” says Sarah Norman, Director and Senior Investment Strategist, Sustainable & Impact Investment Strategy, in the Chief Investment Office (CIO) for Merrill and Bank of America Private Bank. But lately the “S” in ESG—social impact—has gotten special attention.

Amid a global pandemic and stark reminders of racial inequality, increasingly “investors are interested in issues such as economic mobility and how companies treat their workers,” notes Norman. On top of that, Norman believes “the Biden administration’s pledge to pursue policies that advance social progress is likely to boost the momentum of sustainable investing.”

What’s more, growing evidence suggests that companies that have a strong focus on the health of their employees and the communities they serve may outperform those that don’t, Norman adds. As just one example, companies that ranked in the top fifth in treatment of their workers outperformed the Russell 1000 stock index by 4.7% during the following year, according to JUST Capital, while those in the bottom fifth lagged the index by 4.3%.¹ “We believe that the potential for above-average returns lies with those companies that are having a positive impact on their communities,” she says.

Below, Norman and Jonathan Kozy, Managing Director, Senior Macro Strategy Analyst in the Chief Investment Office for Merrill and Bank of America Private Bank, take a look at three key factors propelling the growth of social investing—and what investors can consider now.

An administration focused on social issues

The “care economy” that could result from the Biden administration’s policy priorities includes greater focus on access to health care, childcare, racial and gender equity, education, worker safety and other issues. Companies could likely face greater regulatory scrutiny, not just of their own social policies, but those of the companies they do business with, Kozy says. Companies with high social standards for themselves and their suppliers could potentially perform better financially, thus benefiting those who invest in them, he adds, while those that fall behind could face financial and reputational risk.

Generational change

 “Millennial and Gen Z investors are especially attuned to the idea of stakeholder capitalism versus shareholder capitalism,” Norman says. While returns for shareholders remain important, stakeholder capitalism holds that businesses should be assessed on whether their actions also benefit their employees and the communities they serve, as well as broader society and the environment. Rising interest in stakeholder capitalism in turn supports the idea that growing demand is expected for sustainable solutions and strategies in ESG-related investments overall. Globally, investors plan to double sustainable assets under management in the next 5 years, from 18% today to an average of 35% by 2025, according to a 2020 BlackRock survey.²

Access to better metrics

“Investors interested in factoring social issues into their choices can find a growing array of metrics on the progress industries and countries are making,” says Kozy. The independent, nonprofit Sustainable Accounting Standards Board, for example, identifies the ESG standards most relevant to specific industries. The Social Progress Index, published by the Social Progress Imperative, ranks countries around the world based on issues such as access to the internet, basic education, healthcare and other factors. And the World Bank’s Sovereign ESG Data Portal, launched in 2019, compiles ESG data on countries and regions.

What could this mean for investors?  

While sustainable and impact investing aims to support a healthier society and planet, it’s vital to keep your personal financial goals at the forefront, Kozy says. “Things like corporate productivity and earnings still matter, and so do returns. That hasn’t changed.” Thus, sustainability can be an important consideration when making investment choices, but not the only one. You also need to think about risk, how much time you have until retirement and other key issues, Kozy believes.

Yet as part of building a balanced portfolio, you might ask your advisor to help you identify companies or funds of companies with strong records for supporting their employees and communities, or with innovative approaches to social or environmental issues. Likewise, you may use increasingly sophisticated metrics to lessen your exposure to businesses or regions whose poor ESG performance could mean potential trouble ahead. Notes Kozy, “In the end, ESG provides investors with an additional dimension to help identify market risks and opportunities.”

For more insights, read “Sustainable Investing Under the New Administration”  from the Chief Investment Office.