It’s often said that you need a crisis to help you reach your potential. Perhaps it’s three: In the wake of the Covid-19 pandemic, the economic downturn, and widespread social unrest, the vast inequality between the poor and the rich, between people of color and the white population in America, was finally laid bare enough that corporations—and their investors—have begun to act.
Stakeholder capitalism is having a moment. For many years, most investors argued that it was impossible to reconcile personal values with a successful investment portfolio. Decades of research, not to mention investment performance, have slowly eroded that notion. But never before has there been such a uniform emphasis on companies doing right by all of their stakeholders—investors, sure, but also their employees, their customers, and the communities in which they operate. “If a company doesn’t survive, it’s rubble and there’s no re-employment,” says Doug Baker, the CEO of
Ecolab,
a top-ranked sustainable company, and one of Barron’s best CEOs (see page 18).
Investors are on board. In 2019, flows into U.S. sustainable funds more than quadrupled the previous annual record for net flows, set the year before, according to Morningstar. Today, there’s $120 billion invested in mutual and exchange-traded funds that integrate sustainable principles—also known as ESG, for environmental, social, and governance criteria—with standard financial metrics. That’s up from $30 billion a decade ago. Many firms, such as venerated bond shop Pimco and Boston-based asset manager GMO, have quietly embraced this style of investing throughout their investment processes. This year,
BlackRock,
the world’s largest asset manager, announced that it would put sustainability at the heart of its investment process.
If you think all of this is hooey, you have some powerful allies. The Labor Department this month proposed requiring retirement-plan fiduciaries to choose investments “based solely on financial considerations,” a move aimed at slowing interest in ESG investing. Labor Secretary Eugene Scalia cited “unclear and sometimes contradictory” standards for ESG investing, and accused ESG investors of trying to promote a social or political outcome instead of safeguarding returns for retirement savers. The proposal, which is out for comment, would make it harder for companies to include a default ESG option in their 401(k) plans. Meanwhile, the Securities & Exchange Commission is weighing whether ESG funds need to follow existing rules that require their names to broadly match what they invest in.
Politics aside, this style of investing has consistently beaten the broad market in good times and bad. According to Morningstar, for the past one-, three-, and five-year periods, ESG stock and allocation fund strategies lost less money than non-ESG funds during market declines, and displayed less volatility. For three years, Barron’s has ranked the 100 Most Sustainable Companies, and for three years those companies have beaten the market.
Sustainability is about thinking long term. Long-term investing needs companies that will be around for a while, which means those companies need loyal customers and employees. Corporations began more openly embracing ESG principles in 2017, as the U.S. government seemed to grow intent on rolling back established environmental and social protections. When the U.S. withdrew from the Paris Agreement in 2017, for instance, companies agreed individually to its standards, and began setting emissions-reduction targets to limit global warming. Champions of sustainable practices and good corporate citizenship include CEOs like
Bank of America’s
Brian Moynihan,
Cisco Systems
’ Chuck Robbins, and the influential Business Roundtable.
As Covid-19 savaged employment and communities, companies moved quickly to grant employees extra pay and paid time off for workers needing to quarantine. How a company treats essential workers has become a measure of how responsible it is—providing necessary personal protective equipment, time-off policies, schedule flexibility, physical and mental health care, and child care. Companies also began offering donations to shore up communities. Then came the deaths of Ahmaud Arbery, Breonna Taylor, and George Floyd, and the widespread protests about police brutality and inequitable treatment of people of color. Top-level executives, who once took a hands-off approach to such issues, began speaking out.
This time, the corporate chiefs became impassioned on the subject of racial and social justice. “Even though I’m the CFO of a global bank, the killings of George Floyd in Minnesota, Ahmaud Arbery in Georgia, and Breonna Taylor in Kentucky are reminders of the dangers Black Americans like me face in living our daily lives,” wrote Citigroup CFO Mark Mason in a blog post.
Northern Trust Asset Management president Shundrawn Thomas, who is black, wrote in a post about an experience with a police officer pulling him over and taking his gun out nearly 30 years ago. “It was profiling, pure and simple,” Thomas wrote. “I resolve to break the silence as it pertains to issues of prejudice and discrimination.”
The sustainable-investment community has responded, too. Calvert Research and Management, the sustainable-investment shop owned by
Eaton Vance,
called for companies to assess their racial diversity and disclose it, provide pay-equity disclosure across race and gender, and to publicly state what they are doing to combat racism and brutality.
Another initiative was backed by the Interfaith Center on Corporate Responsibility, which was founded nearly 50 years ago to respond to the human rights abuses occurring in South Africa under apartheid. It is asking investors to commit to a five-point plan that includes establishing targets to either engage with or divest from issuers “that further systemic racism or white supremacy, or that enable state-sanctioned violence and criminalization.”
What’s next? First up: making the workplace more inclusive. Adidas has committed to filling 30% of new hires with black and Latino employees, while Google and
PepsiCo
set targets to expand underrepresented groups among their managers by 30% by 2025.
Such moves will help communities in which they operate, because higher-paying jobs are a pathway out of poverty, even as America crawls out of its worst recession in recent history.
“How people define what the S is will become more granular and more specific,” says Ron Homer, chief strategist for impact investing at RBC Global Asset Management. It will also help with recruiting: Today’s graduates don’t want to work for a company whose top executives don’t reflect the diversity they saw in their classrooms.
And as consumers spend in line with their values, executives will be expected to take positions on things formerly deemed political, such as police behavior. After all, companies are consumers of police services. AT&T CEO Randall Stephenson, for example, recently called for a codification of national standards on the use of force by the police, and said governments should reconsider the qualified immunity that police officers have from civil liability. Customers demand action, and on balance, companies are rewarded.
Nike’s
sales jumped after featuring quarterback Colin Kaepernick in an ad after he was frozen out of the NFL for protesting systemic racism.
There’s plenty to do. While 91% of companies in the S&P 500 have policies to drive diversity and equal opportunity, just 14% have actual targets, according to HIP Investor, a San Francisco–based provider of sustainability ratings, data, and analytics. Only three have black CEOs.
The playbook will resemble what happened as companies and investors woke up to the long-term risks of climate change: Companies began pledging to cut emissions, and investors pledged to hound them, holding boards and management accountable, and making it part of a company’s good governance. “You have protests, you have public health, then it becomes much more of an important issue for boards to accelerate S [factors],” says Vikram Gandhi, a lecturer at Harvard Business School.
Over the long run, companies that outperform on S factors are likely to outperform in the stock market. Companies with superior S scores beat bottom-scoring companies, according to MSCI. A JUST Capital analysis shows that companies that prioritized workers during the coronavirus crisis outperformed those that didn’t. Meanwhile, a recent study by Northwestern professor Aaron Yoon found that employee satisfaction is a necessary condition for a company’s ESG efforts to work, and that companies with high employee satisfaction and high ESG ratings exhibit stronger sales, return-on-equity growth, stock-price performance over time.
The Sustainability Accounting Standards Board has identified social and human capital as key assets to delivering long-term value: Social capital includes a company’s relationships with local communities, issues related to human rights, protection of vulnerable groups, and local economic development; human capital considers the management of employees and contractors. The SEC is considering requiring companies to make disclosures about human-capital management.
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There’s a unique role for large companies to be part of the solution here.
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In addition to pushing companies to expand hiring of diverse employees and managers, investors will also push for more disclosure about corporate demographic data—including the EEO-1 data that companies disclose to the U.S. Equal Employment Opportunity Commission—as a way to track improvement. They will ask for disclosures on all kinds of subjects including race, ethnicity, gender parity, LGBTQ community representation, diversity in boards and senior-level positions, and hiring practices, says Angela Chitkara, a researcher with World in 2020, which publishes research on diversity and inclusion. Says Matt Patsky, CEO of Trillium Asset Management: “This material information is a measure of reputational risk and should be part of data we all have access to.” This year, resolutions asking companies to disclose EEO-1 diversity data earned 70% support at
Fortinet
and 61% support at
Fastenal.
Expect shareholders to wield the power of the proxy. Morningstar counts 30 shareholder proposals this year that deal with racism and inequality. There will be more. For example, Nia Impact Capital has asked Tesla to evaluate the effect of its use of mandatory arbitration to settle harassment and discrimination allegations on its workforce. Nia argues that mandatory arbitration serves to conceal discrimination. Proxy advisors Institutional Shareholder Services and Glass Lewis support Nia’s proposal, which is up for a vote at Tesla’s next annual meeting. “Nobody at the table who decided on that policy was a woman or person of color who’d been discriminated against or harassed,” says Kristin Hull, CEO of Nia. “The people making these decisions need to be a diverse body.”
This year, investment manager Neuberger Berman publicly preannounced its votes for 30 companies as part of an effort to be more effective as an environmentally and socially conscious investor. Many investors will continue to vote with management, of course—after all, those companies are also clients. Nevertheless, “there’s a unique role for large companies to be part of the solution here,” says Jonathan Bailey, head of ESG investing at Neuberger Berman.
One new area of focus will be environmental justice: the intersection of environmental activism and social justice. “The worst air and water pollution are in communities of color,” says Julie Gorte, who oversees ESG research and shareholder and public policy advocacy for Pax World Funds.
Driving it all will be the expansion of sustainable investing. Already, sustainable investors are reporting evidence of increased interest from 401(k) plans in sustainable options this year, even as the Labor Department takes steps to chill demand.
According to a Nuveen study of high-net-worth investors and financial advisors, 54% said they would invest their entire retirement balance into a responsible investment portfolio. Top issues they want their investments to address: fair treatment of employees (48%); human rights (48%); and climate change (47%). “I wouldn’t be surprised if the people who are interested in ESG already are thinking of it in a more serious way, just given the breadth of social issues laid bare by the twin issues of this country,” says Lisa Woll, head of US SIF, the trade group for the sustainable investment industry.
A study by the NYU Center for Sustainable Business found that consumer products marketed as green accounted for 50% of the growth in packaged goods between 2013 and 2018. It may be the same for investments too. Says Catherine Banat, director of responsible investing for RBC Global Asset Management: “This is the moment to draw customers’ attention.”
Write to Leslie P. Norton at [email protected]