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The ‘S’ in ESG Investing

Summary

Part two of our ESG series explains how social metrics can affect supply chains, talent retention, and, ultimately, performance in an investor’s portfolio.

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.

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Footnotes:

1 “How Diverse Leadership Teams Boost Innovation,” by Rocío Lorenzo, Nicole VoigtMiki TsusakaMatt Krentz, and Katie Abouzahr. January 23, 2018.
2 “McCormick Sprinkles A Dash of ESG Incentives Into Its Supply Chain,” by ESG Review Staff. August 18, 2021.

Mercer Advisors Inc. is the parent company of Mercer Global Advisors Inc. and is not involved with investment services. Mercer Global Advisors Inc. (“Mercer Advisors”) is registered as an investment advisor with the SEC. The firm only transacts business in states where it is properly registered or is excluded or exempted from registration requirements.

All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change. Some of the research and ratings shown in this presentation come from third parties that are not affiliated with Mercer Advisors. The information is believed to be accurate but is not guaranteed or warranted by Mercer Advisors. Content, research, tools and stock or option symbols are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. For financial planning advice specific to your circumstances, talk to a qualified professional at Mercer Advisors.

Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that the future performance of any specific investment, investment strategy or product made reference to directly or indirectly, will be profitable or equal to past performance levels. All investment strategies have the potential for profit or loss. Changes in investment strategies, contributions or withdrawals may materially alter the performance and results of your portfolio. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for a client’s investment portfolio There is no guarantee that ESG (Environmental, Social, Governance) investment products or strategies will produce returns similar to traditional investments.  ESG investment criteria exclude certain securities/products for non-financial reasons, and therefore investors may forego some market opportunities available to those who do not use such criteria.

This document may contain forward-looking statements including statements regarding our intent, belief or current expectations with respect to market conditions. Readers are cautioned not to place undue reliance on these forward-looking statements. While due care has been used in the preparation of forecast information, actual results may vary in a materially positive or negative manner. Forecasts and hypothetical examples are subject to uncertainty and contingencies outside Mercer Advisors’ control.

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