Environmental, Social, and Governance (ESG) scorecards give investors a fuller understanding of a company’s performance. The word “social” in the term causes, by far, the most confusion. Investors often mistake it as reference to social values—or worse, social media—but it’s actually about how a company treats people, particularly those in its workforce. This article, the second in our three-part ESG series, defines social metrics and explains how they strengthen an investment analysis.

The first article of the series, on environmental metrics, introduced ESG methodology. To recap, ESG metrics are an additional set of factors for analyzing a company’s ability to generate positive financial returns. 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.

Workforce variables

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. For example, high retention rates, and the human resources practices that drive them, benefit investors because the cost of employee turnover can eat into a company’s profits.

Does the company have a diverse workforce? If not, has it started to implement more inclusive hiring practices? Will it miss out on new business opportunities? Research from Boston Consulting Group, as well as several other respected consulting firms, found that increasing diversity and inclusivity often leads to the creation of additional profitable business opportunities.¹

Supply chain standards

The characteristics of a company’s supply chain are an important component when assessing its social metrics. McCormick & Company stands out in the grocery store aisle with its small-quantity shakers of herbs and spices. In the packaged-food industry, McCormick also stands out as an ESG leader with consistently high ratings. Founded in 1889, it is now one of the highest rated social conscious companies in the world.

McCormick’s supply chain starts on small farms in developing countries such as Indonesia and Vietnam, and then relies on regional suppliers. The company offers suppliers financial incentives to improve the lives of farmers who grow the herbs and spices. Suppliers qualify for discounted rates on short-term working capital financing if they meet standards McCormick has set for women’s empowerment, farmer resilience, and worker health and safety, to name a few.²

A holistic view of business that considers ESG areas has led McCormick to take proactive measures in ensuring the continuity and sustainability of its supply chain. Improving the lives of farmers is part of a strategic approach to managing its bottom line.

Data disclosures

Social metrics extend beyond the workforce to other groups of people. They enable a company to understand its positioning on issues such as consumer protections, data privacy and security, and underserved communities’ access to products and services.

At present in the U.S., ESG data disclosures are voluntary. Each year, more and more companies provide data, in response to a combination of peer, investor, and anticipated regulatory pressures. Mandatory disclosures, with standardized requirements, would benefit investors by allowing clear comparisons among industry peers.

ESG metrics help investors look at issues that are not necessarily part of standard financial statements but can, in fact, have a financial impact. Companies with strong social scores have more stable workforces, responsible supply chain practices, and adherence to strict protocols for consumer protections. These characteristics typically result in reduced financial risk and, at the same time, help improve a firm’s 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 preserve and build wealth.

Next month, this series concludes with an exploration of governance metrics. In the meantime, if you’re interested in applying ESG filters to your investment portfolio, please reach out to your advisor. We can guide individuals in aligning their investments with their choice of impact-oriented priorities in a well-diversified global portfolio that plans for their long-term financial future.