Svetlana Borovkova: The S is an emerging trend in ESG

March 9, 2021

By Svetlana Borovkova, Head of Quant Modelling at Probability & Partners

Sustainable investing and ESG (Environmental, Social and Governance) issues in investing are currently the key investment themes. Environmental aspects of a company’s operation (the E in ESG) have attracted a lot of attention in the past few years. These aspects are well-measurable (for example, CO2 emissions of a company) and resonate well with climate change issues.

Governance issues (the G in ESG) have been studied by investors long before ESG became a trend: studies from as early as the 80s and the 90s have shown that well-governed companies are less risky, have higher credit ratings and produce higher returns.

However, the S in ESG – social aspects of a company’s strengths and weaknesses in dealing with society, workforce and politics – has so far remained a ‘poor relative’ of the E and the G.

Investors of the future

This, in my opinion, is about to change. The COVID-19 crisis had (and continues to have) a sustained and profound impact on all three of these external environments: society, labor force and politics. How companies will manage their relationships with their workforce, the societies in which they operate and the political environment after the COVID pandemic will determine their long-term survival, livelihood and hence, their attractiveness to investors.

Let us start with the workforce and labour market. The pandemic has resulted in an unprecedented amount of economic hardship and unemployment worldwide. This will test the willingness of companies to forgo profit for the sake of not abandoning their workers in such hard times.

In my view, a humane approach to this will be generously rewarded by the investors of the future, particularly the millennials. On the other hand, putting shareholder value above social values will be a risky strategy for companies, again, due to growing pandemic-induced economic hardship and inequality. Those companies that persevere with such a traditional profit-focused approach will suffer massive reputational damage and will be seen as inhumane, soulless and ultimately unsustainable.

Relationship with society

Next, and a related issue, is the company’s relationship with society. Social responsibility towards company’s customers, its supply chain and local communities (particularly those most badly affected by the pandemic) will, in my view, be valued by investors above a company’s focus on profits.

Contribution towards higher societal goals – ranging from food support, tackling poverty, lagging education chances due to lockdowns (or even development of a space program like that of Elon Musk) – will evoke enthusiasm of the younger generation of investors, putting societal issues right at the forefront of the ESG debate.

Safety of a company’s product – think about COVID vaccines of pharmaceutical companies – and fair relationships with the company’s supply chain will also become increasingly important in the eyes of investors.

Challenges for ESG data providers

Finally, in our current extremely politically divided reality and major ongoing onslaught on fundamental human rights, the old wisdom that the market tends to reward those companies that minimize their exposure to social and political issues will cease to hold.

Companies actively contributing to a free, fair, less polarized society and more stable political situation will emerge as winners of the ESG debate in the long term, due to the strong sense of justice and freedom of the new generation of young investors.

Increasing importance of the S in ESG will also pose challenges for ESG data providers such as Refinitiv, Moody’s and others. Strengths and weaknesses of companies in relation to societal issues will be measured in a myriad of new, previously unthought of ways.

But one of the unexpected effects of the COVID 19 pandemic on sustainability investing – increased attention to the S in ESG – should not be ignored by any participant in the investment process, be it asset manager, data provider or a risk professional.

Probability & Partners is a Risk Advisory Firm offering integrated risk management and quantitative modelling solutions to the financial sector and data-driven enterprises.

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