What is the “S” in ESG?

How can a company manage its relationships with its workforce, the societies in which it operates, and the political environment? This is the central question behind the “S” in ESG investing — the social aspect of sustainable investing.

A number of social factors can affect a company’s financial performance, ranging from short- to long-term challenges:

• How can a company's workforce requirements and composition present problems for the organization in the future? Labor strikes or consumer protests can directly affect a company’s profitability by creating a scarcity of skilled employees or controversy that is damaging to a corporation’s reputation.
• What risks come with the safety implications of a product or the politics of a company’s supply chain? Corporations that ensure their products and services do not pose safety risks, and/or minimize the exposure to geopolitical conflicts in their supply chains, tend to face less volatility in their businesses.
• What future demographic or consumer changes could shrink the market for a company’s products or services? Complex social dynamics, from surges in online public opinion to physical strikes and company boycotts by different groups, affect long-term shifts in consumer preferences. Decision-makers can consider these as important indicators of the company’s potential.

If the other aspects of ESG – environmental and governance risks and opportunities –are primarily concerned with a corporation’s effects on the planet or on its internal and political functions, social factors are primarily those that will arise in the relations between a company and people or institutions outside of it. Sustainable investors will try to minimize the risk that societal factors pose to returns. As with ESG investing as a whole, showing a preference for companies that pay attention to these social issues can be a way for investors to reflect their values in investing, while also leading to higher and more reliable returns over the long term.

These social factors are not as complex and abstract as they might sound. For example, Walmart became a more palatable choice for socially minded investors after it announced in September that it would restrict the types of firearm ammunition that it sells, as reported by S&P Global Market Intelligence. Beyond any political points that this move might have scored in the wake of high-profile shootings, including at two of the company’s stores, it reduced the risk that selling ammunition posed to the company’s image. There was some pushback, but S&P Global Market Intelligence found that people were more likely to shop at Walmart, on average, after the change was announced.

Social factors don't just depend on how consumers will judge a company’s behavior. Geopolitical events also fall under the social category in ESG investing and conflicts like these can prevent companies from producing or distributing their products. A textbook case of this was the September drone attack on an oil refinery in Saudi Arabia, which temporarily halted roughly 5% of worldwide oil production. Many analyses after events like this, including questions about the likelihood of prolonged conflict, belong in socially minded investing, and S&P Global Ratings analyzes these topics accordingly. S&P Global Ratings sees oil and gas companies as tending to have high exposure to social factors in all ESG categories (not just environmental factors), given the serious damage that accidents or changes in government policy and inter-governmental conflict can do to a company’s performance across a variety of indicators.

Labor issues also fall under the social aspect of sustainable ESG investing. Sometimes, the impact of labor disputes or challenges on a business are obvious, such as striking auto workers. In other cases, however, these factors can be the indirect result of broader economic trends. As American retailers have been spending more on seasonal workers in 2019 because unemployment is low, S&P Global Market Intelligence reported in August that Kohl’s hired its seasonal workers two months earlier than usual because of the tightening labor market.

Because these indirect factors can be hard to tease out in the market, S&P Global remains committed to providing essential intelligence on the newest issues and trends in ESG investing to accelerate progress and help investors make decisions with confidence.

In creating our ESG Evaluations, S&P Global Ratings analyzed more than 2,000 studies on the impact of considering ESG factors in investing, and more than 90% found that these techniques led to either average or above-average returns. Taking social concerns into account when investing, especially as part of a comprehensive ESG investing strategy, can protect investments. Some believe that prioritizing social factors in sustainable investing ensures that the companies included in an investor’s portfolio reflect his, her, or their values or pass a moral test. However, the prospect of profit creates another basis for examining the social impact and liability of a company and its practices. Simply put, the market will tend to reward those companies that minimize their exposure to these social issues—selling controversial products, relying upon materials from geopolitical hot spots and using an unpredictable labor force can hurt profits and increase volatility.