Exploring the financial materiality of social factors

Jun 30, 2021

In Brief

Covid-19 has led many types of inequalities to widen over the past year with implications for economic growth, investment returns, government policies and meeting the Sustainable Development Goals (SDGs)
Asset managers have a range of options to address the financial materiality of social issues. Norms-based screens can help avoid the financial risk of laggard companies or seek to profit from companies with strong practices
Engagement can encourage investee companies and governments to help improve equality and avoid social harm. This can be particularly effective if done through coalitions such as the "Just Transition". Private debt and equity impact investments can enhance equality by creating agricultural jobs in Africa or improving financial inclusion
If companies fail to respect the principles and guidelines of social norm conventions and protocols such as paying a decent wage or dealing fairly with suppliers, then ultimately they risk losing their social license to operate

International
ESG
Sustainability
Industry

Michael Lewis

Head of Research, ESG

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Summary

Indeed, in a report^[1] by CREATE-Research and DWS published last month it found that 59% of investors polled cited Covid-19 as a key driver of their heightened interest in the Social pillar because of its growing materiality. As well, 66% of investors polled regard employees as financially the most material component of the “S” pillar. The fact that social bond issuance increased tenfold last year compared to 2019 provides further evidence of the rising importance of social factors from a financial perspective:^[2]

These latest observations reinforce the findings of a number of DWS white papers we have published over the past few years which have examined the materiality of social issues on corporate financial performance (CFP), how corporate reputation has one of the strongest correlations to CFP, why shareholder primacy is being rejected in favour of stakeholder-centric capitalism and how integrating social factors into investment portfolios can deliver secondary market exposures:^[3]

Yet when it comes to globalisation, digitalisation and the associated productivity gains, these have been increasingly accruing to the owners of capital rather than labour. Left unchecked, a focus on shareholder value to the exclusion of all else holds risks since the pandemic has triggered an even greater examination of the support mechanisms companies are providing to their employees, contractors and customers and how this affects company performance.

This paper is organised in three sections. The first provides an overview of the financial materiality of social factors and the guiding principles companies need to consider. The second section focuses on the double materiality of how widening social disparities, aggravated by the pandemic, affect economic growth and the SDGs, while the final section assesses how asset managers need to respond when it comes to their investment approach and what role other actors, such as regulators and standard setters, need to play to advance this growing area of ESG investing.

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^1. CREATE-Research, DWS (May 2021). Passive Investing 2021: Rise of the social pillar of ESG

^2. Climate Bonds Initiative (April 2021). Global State of the Market Report

^3. DWS Research Institute (December 2015). ESG and corporate financial performance; DWS Research Institute (September 2018). ESG and CFP: Digging deeper; DWS Research Institute (September 2020). Stockholder versus stakeholder; DWS Investment Insights (November 2020). Spotlight on ‘S’ - Integrating the social factor into investment portfolios: