Our prior work has looked at the long-term relationship between MSCI ESG Ratings, corporate fundamentals and market performance. One clear message from this research has been that the companies that MSCI rated most highly on their approach to financially material social risks and opportunities consistently outperformed their lower-rated peers.
Demystifying social risks for business
But what goes into an analysis of financially material social risks and opportunities? Is there a metric investors should be focused on, and can social risks and impacts even be measured in a robust and reliable way?
The MSCI ESG Ratings model groups social issues into four themes: human capital, product liability, stakeholder opposition and social opportunities. The social issues do not all boil down to a single unit of measurement. Instead, each includes an assessment of social data relevant to those specific risks. The human-capital theme assesses the different risks that companies can face related to their (or their suppliers’) workforce, such as the inability to attract skilled talent or low workforce productivity. Our analysis of this theme includes (among other aspects) data related to employee turnover, fatalities, hours lost to injury, strikes and employee satisfaction.
Mapping financially material risks and opportunities: Social themes
Similarly, the product-liability theme includes data on product-safety recalls, regulatory warnings, data breaches and customer complaints. For the stakeholder-opposition theme, we may track legal cases using court records to understand the risks from poor community relations. The social-opportunities theme looks for the upside — i.e., which companies are well placed to reap the financial rewards associated with medium- to long-term positive social impact? The data used in any assessment will be specific to the question. For example, we may look at the nutritional content of a packaged-food company’s products and compare them to guidelines from recognized health organizations to see how well-positioned the company is to benefit from a shift toward healthier eating.
Not all the risks and opportunities covered in the social pillar will be relevant for all companies. Nutrition and health may offer financially material opportunities for a packaged-food company, yet they likely wouldn’t for a mining company. By understanding the relevant risks for each company, and tailoring the data to those specific risks, it is possible to build an overall assessment of the company’s social risks and opportunities.
Global outperformance for companies scoring highly on the social pillar
We found that the companies that scored highest on the overall social assessment in MSCI ESG Ratings outperformed their lowest-scoring peers across all major regions over the past 11 years. This phenomenon was observed across North America, Asia Pacific and Europe, when adjusted for size and sector.[1] Not all regions saw this positive performance trend over all time periods, yet over the past 11 years, the gap between the best and worst performers was evident on a global basis.
Performance of highest- vs. lowest-rated MSCI ESG Rating social-pillar quintiles by region, equally weighted
Scoring on social-risk themes was a key indicator of performance
Of the four social-pillar themes, we found that human capital was the most widely relevant for companies, affecting 99% of constituents in the MSCI ACWI Index over the last five years. This is not surprising given most companies are reliant on employees, whether they’re in-house or part of the supply chain. This was followed by risks in the product-liability theme (relevant for 64% of companies), social opportunities (23%) and finally stakeholder opposition (13%).[2]
For those groups of companies where each of the individual social themes was relevant, we looked at the performance of those we rated most highly on that theme compared to the lowest rated (again, adjusted for size and sector). For each of the themes focused on social risks, the strongest companies outperformed their weakest counterparts. The performance gap was most apparent for the stakeholder-opposition theme, followed by product liability and then human capital. The results for the social-opportunities theme were less convincing — leaders slightly underperformed laggards over the five-year study period.
Performance of highest- vs. lowest-rated quintiles by social theme, equally weighted
Useful signals come from asking the right questions
The performance of social-pillar leaders relative to laggards has been long-term in nature, geographically broad-based and consistent across underlying themes. There may not be a universal metric for investors to focus on when analyzing companies with a social lens. But focusing on the relevant risks and opportunities and using the right data for the right question can provide valuable insights for all investors.