In many ways, environmental, social and governance (ESG) thinking has hit the mainstream, but investors are lagging in their embrace of one piece of that puzzle.

Environmental and governance factors are now recognised by Australia’s financial regulators as relevant to fiduciary decision-making and major institutions routinely consider them. But institutional investors have been slower to integrate considerations of social issues into investment decision-making and this presents a challenge for super funds, whose members are increasingly concerned about issues like the exploitation of workers and income inequality.

At the Conference of Major Superannuation Funds 2018, held in Brisbane, March 14-16, three ESG experts from around the world shared their views on how funds can apply a stronger lens to social issues to enhance investment decision-making and outcomes.

The panel members are: Principles for Responsible Investment (PRI) senior manager, social issues, Bettina Reinboth (UK); Robeco head of active ownership Carola van Lamoen (the Netherlands); and Australian Council of Superannuation Investors manager, equities research and engagement, Mike Harut (Australia). Ahead of the event, we asked each one to answer three questions about how they envisage super funds can enhance the ‘S’ in their ESG practice.

Is it more challenging to integrate considerations of social risks into investment decisions than environmental or governance risks?

 Reinboth: Recognising that social issues are inherently more qualitative, investors often find it challenging to integrate them, as they are not as easy to quantify. Environmental and governance issues are more easily defined, have an established track record of market data, and are often accompanied by robust regulation. Social issues have less mature data to show how they can affect a company’s performance. But issues such as human rights, labour standards and gender equality – and the risks and opportunities they present to investors – are starting to gain far more prominence.

van Lamoen: Typically, more data is available on governance practices and environmental performance of companies than social issues. This makes it more challenging to integrate considerations of social risks into investment decisions than E and G factors; however, it is certainly possible and Robeco has been doing this for many years.

Harut: In general, integrating social risks is more challenging because environmental and governance risks are more likely to have formal reporting frameworks in place. For example, here in Australia, the ASX requires listed companies to submit a Corporate Governance Statement and there are specific reporting requirements in the Corporations Act on executive pay. Engaging with companies about social issues – either directly, via managers or collaboratively – is, therefore, an essential part of understanding the social risks in your portfolio.

What social issues do Australian super funds need to be most aware of in their portfolios?

Reinboth: Human rights, supply-chain risks, labour practices and modern slavery, inequality, diversity, health and wellbeing are just a few. For example, modern slavery and forced labour, which may be found in the complex supply chains of Australian and global companies, may be less evident but, nonetheless, present a significant issue that needs to be seen as part of a portfolio company’s broader management of human rights. It is also crucial for investors to understand and address the social issues and impacts on the climate agenda.

van Lamoen: I encourage Australian super funds and other institutional investors around the globe to watch closely how companies deal with human rights issues and labour standards. These topics are relevant for investments in holdings across sectors. In addition to that, some social risks are specific for certain sectors. For example, for food and beverage companies, it is relevant to look into the risks of using significant amounts of sugar in products, given the huge growth in obesity worldwide and expected upcoming sugar taxes. Another sector-specific example is supply-chain management; that should be high on the agenda for investments in the electronics and textile sectors.

Harut: ACSI is focused on labour practices in the supply chains of ASX-listed companies, including offshore suppliers in countries like Bangladesh, where labour practices have historically been poor and transparency low. Closer to home, wage issues such as fraud and underpayment at franchising companies have been an increasing focus, given recent public scandals. In 2018, the likely introduction of a Modern Slavery Act in Australia will also require our focus.

How can funds start to apply a stronger lens to social issues to enhance investment decision-making and outcomes?

Reinboth: Through active ownership and engagement dialogues with portfolio companies on social issues and by bringing them to the attention of the board and senior management. Funds can also exercise voting power to influence positive corporate behaviour. Investment institutions should integrate ESG issues internally through awareness raising and implementation processes. We encourage collaboration, through the PRI, with like-minded institutions and investors, to increase influence and encourage meaningful corporate disclosure and reporting.

van Lamoen: As a start, I encourage funds to set priorities with regards to the social issues they deem most relevant. Funds can encourage their asset managers to prioritise these issues and to take them, specifically, into account in their investment processes.

Harut: Funds should start by gaining a clearer understanding of how their portfolio may be exposed to social risks.

Useful questions to ask include:

  • Are we invested in companies with supply chains that extend to countries with poor labour practices?
  • Do companies in our portfolio rely on a vulnerable labour force?
  • Are there companies with material health and safety risks in the portfolio? Are they just focused on physical health and safety or mental health as well?
  • Are we investing in companies with large numbers of employees that consistently perform poorly on employee engagement metrics?

The next step is to speak to fund managers about how they understand and price these risks into their valuations and whether they speak to companies about these issues. Engagement – either directly, via managers or collaboratively – is also important, both to understand your risks and to actively influence companies to improve their practices.

READ MORE: All the coverage from CMSF 2018.

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