SI Dilemma: Should investors address social issues?

The UDHR, crafted in December 1948, came out of the ashes of World War II and the creation of the United Nations. The world community made a clear statement that the atrocities committed during the war must never happen again, and that human rights should be codified. The final document was translated into 500 (!) languages¹ and is still a baseplate for human rights.

Although the declaration is not legally binding, it did inspire the development of international human rights law and binding treaties, of which at least one has been ratified by all 193 member states of the UN.

Now, it is mostly up to governments to make sure that human rights are respected in their countries. So how can this topic be relevant for investors then? Social issues have been an issue for asset managers ever since the S became the middle letter of ESG. No one doubts that it should be considered in the same vein as environmental or governance issues – though it has often been considered a middle child without the power of the E and G.

When it comes to investors, the relevance of social issues can be considered from two sides. The way in which companies manage their social issues could have a material impact on their financial results or their business models (financial materiality). For example, a mining company should manage community relations well in order to keep its license to operate.

Sadly, there are tragic examples of when it doesn’t, as seen with the Brazilian Brumadinho tailings dam disaster in 2019 when 270 people died. In textiles, the Rana Plaza factory collapse in Bangladesh in 2013 which killed 1,134 people provides another tragic example. Managing labor issues in the supply chain is a key topic for fashion companies.

Telecoms and IT companies also face social issues. In today’s overly connected internet, social media companies should keep consumer data private and protected in order to not run into big reputational risks. Gaming companies have similarly run into problems with failing to protect staff from labor abuse, the subject of a recent engagement theme at Robeco.

When compared to climate change, social issues are much broader and contain many different topics. Therefore it is difficult to find a positive relationship between social performance in general and financial performance, though some research is available.

Meta-analysis by Margolis et al. in 2009² reviewed over 200 studies and found a small but positive correlation between corporate social performance (CSP) and corporate financial performance (CFP). While this suggests that good social performance may lead to better financial outcomes, the impact is modest, and varies depending on context and measurement methods. Managing social issues well does not financially penalize companies, but in general it also doesn't offer strong financial incentives to pursue social initiatives.

One social topic that does seem to have financial relevance across all sectors is human capital management. The 100 best companies to work for in the US have exhibited significant excess returns over the market going back to 1997.³ Research by Robeco on Glassdoor ratings finds a similar effect.

So, even though it would not apply across the board, social issues are certainly financially relevant for some sectors, and within social issues, human capital management is the most financially relevant factor across sectors.

Next to financial relevance, there is also the impact relevance for investors. For companies, the UN Guiding Principles on Business and Human Rights⁴ describe how countries and businesses should uphold human rights.

National governments have the duty to protect human rights and lay the foundations (laws) for businesses. They should provide effective guidance to enterprises on how to respect human rights throughout their operations, and to encourage, and where appropriate require, businesses to communicate how they address their human rights impacts. Businesses should respect human rights and provide access to remedy.

For example, on 25 July, the EU’s directive on corporate sustainability due diligence entered into force. The new rules will ensure that companies in scope identify and address the adverse impacts of their actions on human rights and the environment inside and outside Europe, including their supply chains. More transparency on this topic will lead to more scrutiny from the market in the coming years and thus more relevance for investors.

The direct impact that we make as investors is very limited. The reporting and due diligence directives in the EU are still very much focused on the direct impacts of businesses (in their supply chains) and are less relevant for the financial sector. We would encourage the EU to develop sector guidance to make these directives more relevant for us.

The impact asset managers make is mostly indirect through managing portfolios in listed equities or fixed income securities. Input from our data providers and our in-house research can highlight the major social issues that our portfolios are exposed to, in their own operations and in their supply chains.