19 July, 2021 / Editorial Panel Contribution

Investing in the ‘S’ in ESG

By Eric Pedersen, head of responsible investments, Nordea Asset Management

Nordea's Eric Pedersen explains the landscape for ESG investing and how to consider social factors

Investing in the ‘S’ in ESG

Milton Friedman once argued the only corporate consideration should be that of profit maximisation. However, protecting societies is good for business, a conclusion shared by investor groups across the globe.

The opposite is also true, companies with weak records on human rights or labour practices are likely to suffer from increased supply-chain disruptions – affecting both operational performance and brand reputation.

Social considerations, the ‘S’ in ESG, are therefore important factors, not only in corporate performance – making companies more diverse, stable and resilient – but also in societal success – making supply chains and communities more resilient.

ESG is here to stay

If anything has taught us the importance of social stability and cohesion, it is the outbreak of Covid-19. Every country, sector and individual has been impacted by the pandemic, which has highlighted the importance of examining the sustainability of global business models more closely. Covid has also been a good litmus test for investors to assess how resilient companies have been in the face of the crisis and the preparedness for any future disruptions.

ESG considerations more generally have taken on particular relevance in light of the ongoing health crisis. While conventional funds were experiencing significant outflows at the height of the crisis, ESG funds actually experienced net inflows. Funds with less ESG risk were also able to better weather 2020.

The inflows imply that ESG investing is not going anywhere anytime soon. In the first quarter of 2021, flows into such funds grew by 19% – to just shy of $2trn. These numbers are expected to increase in the coming years.

Shifting toward the ‘S’

To date, the ‘E’ has dominated focus within the ESG landscape, with environmental concerns such as climate change high on the list of investor priorities, while the ‘S’ has lagged. Regulation on ESG issues has overwhelmingly focused on the ‘E’ and the ‘G’ – something we also see in terms of the availability of corporate data. This is partly because social issues are slightly more difficult to define and are more qualitative in nature.

But this is changing. Regulation is becoming more defined in terms of social issues and – as was the case with environmental reporting – social reporting is moving from the voluntary to the mandatory. Ratings agencies are also recognising the importance of ‘S’ considerations in issuer credit quality.

Recent social justice movements emphasise how people are demanding more of the companies they invest in. This is particularly true among younger investors, who ‘were more attentive to the actions of companies in response to the Covid-19 pandemic. With millennials set to inherit $30trn over the next 40 years, this is a clear opportunity companies and investors can leverage to meet demand.

Bridging the flow gap

Of the 17 UN Sustainable Development Goals (SDGs), 11 are dedicated to social empowerment. However, most ESG inflows are geared to the ‘E’ in ESG. This leaves an annual investment gap of around $2-4trn on social empowerment. We believe this presents a huge opportunity for companies that can meet this demand. For investors, this means bridging the financial gap by backing those companies offering social goods and services. This is not just about prioritising social issues, it also makes financial sense.

Working towards the achievement of the social empowerment-aligned SDGs is in the best interest of investors, as corporate profitability depends on the continued wellbeing of the world’s society. Failing to act on goals like social equity and resource parity may have an impact across geographies and sectors, which in turn could have detrimental effects on the global economic system.

Post-Covid, investors expect a continued interest in ESG factors, but one that goes beyond climate change, to include the ‘S’ factor, which has been particularly exposed by the pandemic. There is an exciting investment opportunity behind this megatrend – and we need to act now. If we are serious about building back better, then investing in companies that prioritise or provide solutions for the ‘S’ will be imperative.

Eric Pedersen is head of responsible investments at Nordea Asset Management and an ESG Clarity editorial panellist.

A part of the Mark Allen Group.