There’s been a lot of attention given lately to ESG investing, but not always a lot of explanation. What the E in ESG stands for is easy to guess -- environmental. The G, governance, is harder to remember but at least is specific. The S on the other hand, is neither easy to guess or pin down: social. It’s a term that can encompass concerns from gender equality to worker rights to new ways to provide funding to charities working in poor countries. What was once a fringe approach has now seen big investors, including KKR, Vanguard Asset Management and Columbia Threadneedle Investments, create funds focused on social concerns. And companies are learning that the rise of S means that bad behavior can be increasingly expensive.

1. What’s the big idea?

There are many subsets to social investing, but the common thesis is that capitalism has obligations that go beyond shareholders and return on equity -- that investors and companies also need to consider their impact on customers, employees, local communities and society in general. While different strands of the social investing movement may focus on labor standards, LGBTQ rights or corruption, they’re meant to send a common message: Businesses need the consent of these overlapping constituencies to operate, and a threat to this ‘license’ can have an impact on their bottom line.

2. This isn’t totally new is it?

Organized efforts at this kind of investing can be traced back decades and include church-affiliated organizations in Sweden that began an ethics-based mutual fund available to retail investors in Europe in 1965 and the Pax World Fund, which launched in the U.S. in 1971. These approaches, which focused on screening out companies seen as doing specific kinds of harm, later came under the term socially responsible investing, or SRI. Over time more companies adopted corporate social responsibility (CSR) policies amid increasing scrutiny of their business practices. Meanwhile some investors advocated what became known as impact investing as they sought to make a positive effect on the world, rather than just avoid the bad stuff.

3. How is ESG investing different from earlier efforts?

The biggest change under ESG is that SRI, CSR and impact investing are now coming under a single umbrella just as ESG has been embraced by policy makers, regulators and an ever-bigger number of investors. An ESG approach is more numbers-based, and typically involves scoring a wide range of information about a firm, from its carbon emissions to safety at work and gender mix in the boardroom. In practice, SRI has been more specific, screening out companies making products deemed harmful, like tobacco or arms, or focusing on individual goals, such as the historic boycotts of South African products because of apartheid.

4. How does social compare with the other parts of ESG?

Environmental concerns have been in the spotlight as policy makers tuned in to climate concerns, but some say investors should now be shifting their attention toward social sustainability -- both because it’s the right thing to do and for its financial benefits. A recent Deutsche Bank report suggested “the S in ESG will increasingly be the ‘next big thing’ when it comes to investor focus.” The claim is that long-term returns will be higher from investing in companies that pay attention to the social part of their business, whether that’s by taking care of their staff or being responsive to customers and the wider environment.

5. Within social, what’s hot?

Impact investing is a fast-growing sector, with over $500 billion in assets globally at the end of 2018, according to the Global Impact Investing Network, though it remains only a fraction of the more than $30 trillion of funds allocated toward ESG strategies. In the U.S., KKR exceeded its $1 billion fundraising goal for its first Global Impact Fund in August. The bond market has also embraced social investing recently, with the outstanding volume of debt rising to nearly $40 billion, almost all of which has been issued in the last three years, according to data compiled by Bloomberg. There are three main types of bond for the socially-focused investor:

• Social bonds: All the money raised must be used to promote improved social welfare and positive social impact directly for vulnerable, marginalized, underserved or otherwise excluded or disadvantaged populations

• Social-impact bonds: To fund a particular project with repayment linked to whether the project achieved its goals

• Sustainability bonds: All the money raised will be used for either green or social activities

6. What risks does a focus on social hold for companies?

It’s not news that companies can be hurt when they’re caught doing something bad for their community. But given the greater awareness of ESG and the way information travels across social media, the impact of getting things wrong is probably bigger than ever before. A recent analysis by Moody’s Investors Service suggested social considerations posed “high credit risk” to $8 trillion of debt that it assesses. Moody’s said emerging-market governments, health-care providers, heavy industries and consumer sectors had the highest risks related to social.

7. What changes are in the works?

Better data and definitions are two big things that need improvement for the movement to grow. In a survey by BNP Paribas SA, 46% of asset owners and managers found social to be the most difficult sector to analyze. Academics at NYU Stern said in a 2017 study that there were bigger gaps in the data around ‘S’ than ‘E’ and ‘G’. The study found that the available data focused on what was convenient to measure rather than meaningful, and that it lacked consistency. Efforts are being made: European authorities have said they aim to follow their classification of sustainable finance with another covering social, though that won’t be for some time. And bodies such as the Sustainability Accounting Standards Board (SASB) are seeking to get universal adoption of standardized reporting that would include social elements. Meanwhile, there’s plenty of experimenting with new approaches, such as ETFs that design their holdings in conjunction with charities that in turn receive a cut of the fund’s investment fees.

To contact the reporters on this story: Tom Freke in London at tfreke@bloomberg.net;Caleb Mutua in New York at dmutua@bloomberg.net

To contact the editors responsible for this story: Tim Quinson at tquinson@bloomberg.net, ;Daniel Hauck at dhauck1@bloomberg.net, John O’Neil

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