Focus on social issues becomes a big factor in investment performance

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Social issues have often received less of a spotlight than environmental concerns in the broader sphere of responsible investing (RI). That might be changing.

The Responsible Investment Association of Canada’s 2022 Canadian RI Trends Report revealed that 94 per cent of advisors and asset managers now use environmental, social and governance (ESG) integration. Equity, diversity and inclusion, labour practices, human rights, and health and safety are among the top 10 factors under consideration.

When choosing investments, advisors have a few key reasons to ensure companies are good corporate citizens on the social front. For one, their clients care.

“Many investors, while concerned about climate change or biodiversity, are now realizing those big issues are deeply connected to social issues like Indigenous rights and the impact of a company’s operations on local communities,” says Fate Saghir, head of sustainability at Mackenzie Investments.

Mackenzie’s annual Earth Day Study, released in April, notes that 81 per cent of Canadians surveyed believe their investments should bring positive social change.

Governance issues – such as concerns about compensation or board and executive diversity – also touch on social elements, Ms. Saghir adds. In many ways, the “S” in ESG is really “the connective tissue” between the other elements, she says.

Moreover, a recent analysis found a strong correlation between better scoring on ESG performance, overall – and social and governance metrics in particular – and superior valuation and profitability.

Advisors and their clients should pay heed to how poor performance on social issues may lead to subpar financial outcomes, says Laurie Clark, founder and chief executive officer of Onyen Corp., a Toronto-based software firm that facilitates ESG reporting.

“If you can’t attract and retain diverse talent, can’t work well with communities in which you operate, or can’t engage your customers on issues they’re concerned about, how are you going to execute on a business strategy to generate profit?” Ms. Clark says.

Poor labour practices or failing to address Indigenous rights adequately are more likely to lead to more immediate blowback with tangible financial downsides, she adds. In contrast, climate change initiatives are often costly and affect the bottom line negatively in the short term, while benefits are more long term and harder to discern for investors.

A recent Onyen survey points to Canadian investors seeing the social priority, with 83 per cent wanting their portfolios to support a fair and just society, and 62 per cent stating COVID-19 and recent social justice events spurred their growing focus.

Well before investors became “woke,” research from global nonprofit, Catalyst, published in 2004 found a relationship between financial performance and gender parity. Firms with the highest representation of women in management had 35 per cent higher returns on equity than firms with the lowest levels of women leadership.

It’s only in the past few years that investors seeking sustainable portfolios have asked asset managers for a greater focus on social issues, says Mike Thiessen, co-chief investment officer with Genus Capital Management Inc. in Vancouver.

“Even when they did, one challenge has been that there wasn’t great data to make investment decisions based on social metrics.”

That has changed with work from data analytics companies such as Onyen and Sustainalytics. “Now, for example, we can remove companies from our sustainable portfolios that score from moderate to worse on conflicts involving Indigenous communities around the world,” Mr. Thiessen says.

What’s more, Genus can measure how a company’s social score may affect financial performance. Mr. Thiessen points to Genus research on the financial performance of the top 10 per cent of companies in Canada for health and safety versus the bottom 10 per cent. It found that between Dec. 31, 2010, and Dec. 31, 2020, the top companies’ stock prices outperformed the bottom companies by about five percentage points annually, on average.

Potential outperformance aside, the ability to screen out companies with poor track records on Indigenous rights and equality has led to Genus being shortlisted by more would-be clients.

“Typically, we have always had environmental foundations seeking our services. Now, we’re seeing more socially focused foundations,” Mr. Thiessen says.

Prudent investors and advisors recognize that companies with a strong performance on social factors are generally better investments as these firms are less likely to become embroiled in controversy, Ms. Saghir says.

“After all, firms that treat their employees, customers and communities well will likely have more sustainable long-term business prospects than those cutting corners to chase the next dollar.”

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