'It’s time to focus on the ‘S’ in ESG' writes Research Fellow Dr Ana Nacvalovaite

Kellogg Research Fellow Dr Ana Nacvalovaite explores how in discussions about ESG, we are placing too much emphasis on the ‘E’ and ‘G’

In recent years, environmental, social and governance (ESG) investing has gained immense momentum as people are becoming increasingly aware of the impact that their investments can have on the environment and society. This is because the world is facing a multitude of environmental and social challenges, and it is therefore essential that companies and investors recognise the role that they play in addressing these issues, and ensure that their investments align with their values.

There are significant differences between generations when it comes to investment characteristics, which is one of the reasons why ESG has come to the forefront for investors. Indeed, with the rise of social activism and awareness, it could be argued that today, more and more people demand that businesses and investors prioritise the environment and people over profit, or at least balance these priorities more equally. Many believe it is no longer enough for companies to simply meet legal requirements and avoid negative headlines – they must take proactive steps to address social issues and promote sustainable development.

Generation game

As such, cooperative activity is rapidly growing throughout the world, amidst a new generational approach to investment profiles and financial values. The key generations are Baby Boomers, born between 1946 and 1964, Generation X, born between 1965 and 1980, Generation Y (the Millennials), born between 1981 and 1996, and lastly Generation Z, those born after 1997. Those categories reflect more than age, the symbolise each generation’s collective identity as they go through formative experiences, including how they deal with financial situations.

Each generation thinks about investments differently, because of their stage in life. As Baby Boomers retire, Generation Z will grow up and accumulate money. Millennials, meanwhile, pursue their quest in their search for more responsible and sustainable investments, aligning themselves to ESG principles. They seek a diversity of social-based investments, through a gender lens, defending under-represented communities, and supporting minority-owned businesses, among others.

So, millennials and Generation Z now represent a powerful force for change in financial tendencies, which is having a deep impact on mainstream investors. Their actions have great consequences in revenue and social impact. One practical consequence is that all generations are slowly turning to the ESG agenda to keep up with financial market trends – even though they are themselves helping to form them.

Because of this, investors are increasingly taking the lead in evaluating companies based on their ESG performance, and many large institutional investors have made significant commitments to ESG investing. This trend is expected to continue as investors increasingly recognise the financial benefits of this and the need for companies to consider the social impact of their actions. This force for change can also be felt on a political scale, and social issues and human capital is making its way to the top of government agendas. In fact, at COP27, ESG and sustainable finance was a primary topic for exploring ways to ensure that investments become more climate-friendly as well as assisting with the “just transition”.

Yet, despite this, it could be argued that the emphasis was on the “E” and the “G” – the environment and the governance aspects – particularly for supporting strong governing organisations, for high environment standards, and for the fight against corruption. Therefore, despite the growing interest in ESG, the social component has historically been overlooked in favour of environmental and governance aspects, despite issues such as poverty and discrimination impacting all corners of the globe.

But what is the “S” in ESG, and why is it important? Well, according to the UN Global Compact, social sustainability involves identifying and managing a firm’s positive and negative impacts on a community. This includes ensuring that workers are treated fairly, providing equal opportunities to all, and working to address social disparities. From a business perspective, social considerations such as diversity and inclusion, worker rights, and human rights, can play a crucial role in determining the long-term success and sustainability of a company.

Investing in companies with strong social sustainability performance can provide benefits, such as reduced risk, improved financial performance, and a positive impact on the wider community. In fact, without also focusing on social issues when investing, companies will hinder the progress they will make relating to the “E” and the “G” – all components must be considered in unison.

Indeed, if a business does not concern itself with social wellbeing in their operations, its investments will not fulfil their potential. Supporting and respecting human capital is a paramount ingredient for successful, sustainable finance for future generations.

An interesting example of “S” being at the centre of business are cooperative businesses, as they share important concerns and targets of ESG and Sustainable Development Goals, which therefore makes them great opportunities for investment. Many cooperatives have achieved great size and importance, and along their way have transformed communities and economic sectors, such as credit unions, agriculture, and the rural electric sector.

So, as we look ahead, the “social” or “S” elements of ESG will certainly rise in prominence, having played a secondary role to environmental and governance factors for some time. As a combination of generational trends in investing and emerging regulation prompts firms to increase their focus on social issues, more businesses are realising that social issues should be an integral component of their sustainability strategy. An organisation’s purpose can only be fulfilled if environmental and social challenges to the business are considered together.

In addition, investing in companies that prioritise social responsibility and sustainability not only aligns with an individual’s values, but it also makes good business sense. Companies with strong social and environmental policies are more likely to attract and retain employees, customers, and investors. Additionally, as mentioned above, research has shown that companies with strong ESG performance tend to have better financial performance and lower risk compared to their peers.

It’s time to put the “S” in ESG in the spotlight and prioritise social responsibility and sustainability in our investments. The world is facing significant social challenges, and it is our responsibility to ensure that our investments align with our values and promote a just and sustainable future.

This article first appeared in The European on 21 April 2023.

Dr Ana Nacvalovaite is member of Kellogg’s Centre for Mutual & Co-owned Business