The ‘S’ in ESG Investing

Environmental, Social, and Governance (ESG) analysis aims to assign scores to companies based on concerns raised within those three distinct areas. This level of research performed by third-party entities can give investors a fuller understanding of a company’s ability to mitigate its risk in ESG matters. Companies scoring highest are expected to outperform when met with challenges identified by ESG concerns, in comparison to their lower-scoring peers.

This article, the second in our three-part ESG series, defines social metrics and explains how they strengthen an investment analysis. The social score attempts to measure a company’s treatment of their employees and the communities in which they do business. Investors looking to align their portfolios with their social values may consider utilizing this lens.

The first article of our series on environmental metrics introduced ESG methodology. To recap, ESG analysis is an additional set of criteria used when analyzing a company’s ability to generate and sustain positive financial returns for investors. Scores assess the risks — or opportunities — a company faces in these three areas, and how the company is addressing them in comparison with its industry peers.

What are social metrics?

Social metrics enable investors to analyze human resource management, supply chain practices, social impacts, staff diversity, and inclusion efforts as components of a company’s business model. The social score tells us how well a company manages the risks associated with these issues.

Humane treatment

It’s no surprise that employees who are valued and respected tend to have more enjoyable careers and stay with their employers longer, creating less turnover. Additionally, studies show that having a diverse workforce can increase innovation and improve financial performance.¹

Social metrics can also help with avoiding conflict risk internationally. Companies that are found doing business in high-risk regions, such as oppressive regimes, or those funding terrorism, can be identified through ESG analysis — allowing investors to exclude these companies from their portfolio, if they choose.

Product liability

It is becoming increasingly important to investors that the products they consume are safe for them and their families. For example, product liability is a factor when considering the quality of a manufacturing company. Technology companies are expected to have privacy and data protection practices in-place. The finance sector is evaluated for their commitment to ethical practices. The reputational risks associated with repeated health and safety violations, or discrimination lawsuits, will affect a company’s “S” score.

Supply chain practices

In measuring labor standards, analysts evaluate how a company manages the health and safety of its employees, as well as the standards it has in place throughout its supply chain. Investors are looking more closely at the supply chains of companies through ESG analysis which might provide exposure of companies funding child labor and unsafe working conditions. Investors can now choose to exclude companies with supply chains that are profiting from forced child labor.

Investor demand for information

Most large companies are now reporting on their ESG matters.² In early 2024, the SEC ruled to standardize climate-related disclosures. Due to increasing investor demand for transparency and consistency in data reporting, the SEC responded by enhancing an already-existing rule that applies to public companies. Companies are required to disclose data related to their potential climate risks, efforts made to mitigate risks, stated targets to reduce risks, estimates and assumptions used in calculating these risks, and the costs associated.³

ESG metrics help investors look at issues that are not necessarily part of standard financial statements but which can, in fact, have a financial impact. Companies with strong social scores have more stable workforces, adhere to strict protocols for consumer protections, and have responsible supply chain practices. These characteristics typically result in reducing a company’s financial risk while also improving its profitability. Adding the ESG lens to traditional financial analysis helps us identify the some of the financially strongest, best managed companies to include in investment portfolios to help with preserving and building wealth.

If you’re interested in applying an ESG lens to your investment portfolio, please reach out to your wealth advisor at Mercer Advisors. We can guide you in aligning your investments with your choice of impact-oriented priorities in a well-diversified global portfolio that plans for your long-term financial future. If you are not a client, but would like more information, let’s talk.

To learn more about ESG investing, we encourage you to read the other two articles in this series:

• The ‘E’ in ESG Investing
• The ‘G’ in ESG Investing

¹ “How Diverse Leadership Teams Boost Innovation,” by Rocío Lorenzo, Nicole Voigt, Miki Tsusaka, Matt Krentz, and Katie Abouzahr. January 23, 2018.

²  “Momentum Builds for Corporate ESG Disclosure and Assurance, Yet Reporting Inconsistencies Linger, Study Finds” 2/27/2023.

³ “SEC Adopts Rules to Enhance and Standardize Climate-Related Disclosures for Investors”