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Integrating social metrics into investment analysis

Che Sidanius
Che Sidanius
Global Head of Financial Crime & Industry Affairs, Refinitiv / Chair of the Europe Chapter, Coalition to Fight Financial Crime

As investors come under pressure to incorporate social metrics into their capital allocation processes, a new white paper co-authored by Refinitiv addresses five common myths associated with the ‘S’ in ESG.

  1. Refinitiv launched a white paper with a group of industry partners which debunks five myths related to the ‘S’ in ESG, and explores how to more effectively integrate social metrics into investment management.
  2. The myths analysed in the white paper include the beliefs that ‘social performance is less financially material’, ‘social indicators are hard to measure’ and ‘qualitative surveys are the best method for tackling social issues’.
  3. The white paper provides investors with practical pathways to improve their use of social indicators, and identify more resilient and profitable investment opportunities.

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At Refinitiv, we maintain that better integration of social indicators can help identify more resilient and profitable investment opportunities. Yet their relevance to investment analysis is often downplayed partly due to the perception that social metrics are immaterial compared with environmental or governance indicators.

There’s also a widely held belief that social issues are strictly the domain of governments rather than the private sector and investors.

Download the ‘Amplifying the “S” in ESG’ white paper

Image from the Integrating social metrics into investment analysis blog

Debunking myths related to social metrics

In recognition of the limited progress made in the integration of social metrics into environmental, social and governance (ESG) investing,  we have partnered with the Thomson Reuters Foundation, International Sustainable Finance Centre (ISFC), White & Case, Eco-Age, the Mekong Club and the Principles for Responsible Investment (PRI) – an observer participant – to improve and expand the use of social indicators.

To mark the start of our collaboration, we have published a white paper which aims to debunk five common myths related to the “S” in ESG and provide practical calls to action on how to strengthen social metrics in investment management.

Myth 1: Social performance is less financially material

A company’s social metrics, including its labour and supply chain practices, are often dismissed as immaterial because of the false belief that they present a lesser risk to revenue streams, and are less likely to be subjected to regulatory scrutiny or other punitive measures.

In reality, poor social performance can lead to significant reputational and financial damage. The COVID-19 pandemic and the Black Lives Matter movement have highlighted the need for companies to prioritise employee health and safety, and rethink their approach to diversity and inclusion (D&I).

Image: Fact 1 - Social issues are key risks to all investors and their beneficiaries. Image from the Integrating social metrics in investment analysis blog

Online fashion retailer Boohoo saw $2 billion wiped off its market value in August 2020 following an undercover investigation which revealed that staff were paid less than the minimum wage and did not wear protective masks to prevent the spread of COVID-19.

Amid a series of high-profile resignations, the founder of fashion brand Reformation and the editor-in-chief of lifestyle website Refinery29 have both stepped down because of public backlashes over discriminatory hiring policies and management styles.

Regulation is also catching up. Governments around the world are looking to require companies to disclose what impact they have on both society and the environment.

Modern slavery laws in the UK, Australia and California, for example, have introduced mandatory reporting for companies of a certain size on steps taken to address modern slavery risks in their supply chains.

Action: investors should identify the social issues that are material to the sector or jurisdiction they are investing in and build in-house capacity to better understand social metrics. They must also scrutinise investee companies on the reporting of their social impact and ensure they disclose any potential missing information.

Read an overview of current disclosure requirements of social metrics by regulators and stock exchanges around the world, prepared by White & Case.

Myth 2: Knowing how and where to start assessing social performance is challenging

Determining the scope of the “S” in ESG can be challenging because it covers a host of different issues, and because the material risks presented by social issues vary based on country and industry.

In the U.S., healthcare benefits and D&I might be top of mind, while in many developing countries, human rights abuses, supply chain transparency and corruption would warrant greater focus.

In reality, the link between business and human rights is well established. The challenge is not the lack of tools, but the sheer volume of frameworks that makes it difficult for companies to choose the right reporting mechanism to track their social metrics.

Fact 2: The link between business and human rights is well established. Image from the Integrating social metrics in investment analysis blog

Action: our white paper lists resources that can help improve your understanding of social metrics. The UN Guiding Principles on Business and Human Rights (UNGPs), for example, provide an ideal starting point for investors new to social performance assessment.

In addition, Annex I of the white paper provides a comprehensive mapping of social indicators against key sustainability reporting frameworks, including the Global Reporting Initiative (GRI), the Sustainability Accounting Standards Board (SASB), and Refinitiv’s ESG data.

Watch – Refinitiv Perspectives LIVE: From ESG to the SDGs: How can we achieve sustainable development?

Myth 3: Social indicators are hard to measure

Lack of standardisation has led to the misconception that there is not enough reliable or comparable data on social performance to be used in investment analysis.

In reality, data quality and availability on social issues have improved over the last decade, although lack of data harmonisation and a relative shortage in company disclosures are still key challenges.

Face 3: It is possible and necessary to start using social indicators more. Image from the Integrating social metrics into investment analysis blog

Action: reviewing the indicators provided by the GRI and SASB can be a good starting point to integrating social metrics, but investors must dig deeper to identify the most useful indicators for their sector and jurisdiction.

The white paper lists a range of relevant data sources on issues such as gender and racial diversity or supply chain transparency, but it’s important to monitor this space as new resources continue to emerge. Investors should also use a combination of different data sources as data vendors often differ in their scope and focus.

In addition, technology plays an equally vital role in improving social metrics.

Satellite imagery can help to more easily detect illegal labour in construction sites, mines or forests, while blockchain technology can improve supply chain transparency through more sophisticated authentication processes.

Natural language processing (NLP) models can be trained to analyse news or social media sentiments to better understand market perception or to detect ESG controversies. Our recently launched Refinitiv MarketPsych ESG Analytics tool offers quantitative ESG insights based on real-time news and social media monitoring.

Myth 4: Qualitative surveys are the best method for tackling social issues

Investors typically rely on qualitative questionnaires to assess a company’s social performance, but these basic, box-ticking surveys tend to focus on corporate policies alone rather than their social impact.

In contrast, data-driven input such as the social indicators listed in Annex I can help investors assess the impact of a company’s social measures and identify potential ‘red flags’. Comparing data points over time can also help track companies’ progress on their social targets.

Qualitative approaches can be enriched by data-driven elements. Image from the Integrating social metrics into investment analysis blog

Action: investors should use a combination of quantitative and qualitative analysis for more robust due diligence, consult NGOs and other field experts for a better understanding of red flag issues, and engage businesses ahead of time to address these risks.

The use of relevant benchmarks and indices such as the World Benchmarking Alliance’s Gender or Corporate Human Rights Benchmark, KnowTheChain or Ranking Digital Rights is also becoming a common practice to assess companies.

Myth 5: Integrating social metrics is only relevant for impact investors

Mainstream investors often believe that improving their social metrics will distract efforts from a ‘returns first’ mentality, although there is no evidence that integrating social metrics – or ESG in general – would lead to diminishing returns.

Qualitative approaches can be enriched by data-driven elements. Image from the Integrating social metrics into investment analysis blog

In reality, analysis of ESG fund performance over the last decade shows greater resilience by these funds compared with the wider market during times of crisis, such as the 2008 financial crisis or the COVID-19 pandemic.

In addition, Refinitiv’s D&I study revealed that portfolios that took diversity of employees and boards into account have also outperformed their peers.

Social metrics can help identify more resilient and profitable investment opportunities. Image from the Integrating social metrics into investment analysis blog

Action: gaining a better understanding of material ESG issues can help investors identify under-priced but long-term profitable opportunities. Integrating ESG into your investment and business practices can also serve to attract and retain top talent.

In addition, investors should also consider joining industry bodies that look at tackling critical social issues such as the Investor Alliance for Human Rights or the Human Capital Management Coalition that focuses on driving worker health and safety, living wages and D&I.

5 Myths Related To The 'S' In ESG. Download the white paper: Amplifying the “S” in ESG, from the Integrating social metrics into investment analysis blog