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Understanding the “S” in ESG investing

When you hear about ESG investing, where environmental, social, and governance factors are considered alongside financial ones, the social issues can sometimes be overlooked. Yet, when you break it down, the issues covered by this pillar are often important to investors.

It’s not just the ethics of social issues that might mean investors want to consider them either, they could improve a company’s resilience and long-term profitability too. Read on to find out why.

“Social” measures the impact a company has on employees, customers, and communities

The S in ESG investing refers to the social impact a company has. That means considering how it interacts with its employees, customers and the communities where it operates.

It can cover a broad range of issues that might be important to you, such as:

• Labour rights and working conditions
• Diversity and inclusion in the workforce
• Human rights across supply chains
• Rights of indigenous communities
• Customer privacy and data protection
• Product safety and consumer protections.

In short, the social part of ESG investing means evaluating how a company addresses key social challenges and the long-term relationship it builds with stakeholders.

Strong social policies could support a company’s success

While social issues might seem like they’re about doing the right thing, they may positively affect the success of a company too. They could play a role in both risk mitigation and value creation.

Risk mitigation

All companies face risks that could reduce their profitability which, in turn, may affect the value of the stocks and shares that investors hold. In many cases, social policies can play a critical role in risk management.

For example, a company that has strong labour policies, such as ensuring safe working conditions and paying a fair wage, is less likely to face legal challenges from employees or strikes. Overall, this could mean the business is less likely to face unexpected costs that could derail short- and long-term profitability.

Similarly, a company that works closely with local communities might face fewer objections when they want to expand operations.

So, as an investor, a company that sees value in social policies could be more resilient and present less risk when compared to companies that don’t.

Value creation

Social policies aren’t just beneficial because they may reduce risk, they often play a role in value creation too. Indeed, they could play an essential role in helping a business grow and deliver profits to its investors.

A company with happy employees will typically have a higher retention rate and be attractive to prospects when they’re hiring. This could allow them to secure the top talent in the industry. Improved employee welfare could add value in other areas too, from increased productivity to fewer absences.

Social policies might support business goals in other ways as well. For example, a company that has a strong reputation for treating customers with respect could see sales rise as a direct result of the goodwill created. Or consumers might opt to purchase products of one business over another if they know employees across the supply chain have been paid a fair wage.

While investment returns cannot be guaranteed, social policies could help the value of a business grow over the long term.

The challenge of measuring social impact

One of the key challenges with the social aspect of ESG investing is measuring the effect policies have.

While a company can use data to support its ambitions to reduce its carbon footprint or waste, quantifying areas like employee satisfaction or community impact can be far more difficult. From an investor perspective, it can make accurately comparing companies’ social performance challenging.

The good news is that there are investment funds with an ESG focus, which could allow you to incorporate ESG values into your investment strategy without having to research individual companies.

There are many ESG funds to choose from, with a variety of risk profiles and ESG criteria to select. However, keep in mind that funds may not perfectly align with your values, so you might need to be flexible in some areas.

As with any investment, ESG investing involves risk and there’s a chance you could lose some of your money. Before you invest, it’s important to consider if the level of financial risk is appropriate for you and whether it supports your long-term goals.

Contact us to talk about aligning your investments with your values

If ESG investing is something you’re interested in, please get in touch. We can work with you to understand how you might balance your financial aspirations with values that are important to you when you’re investing.

Please note: This blog is for general information only and does not constitute financial advice, which should be based on your individual circumstances. The information is aimed at retail clients only.

The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.

Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.