Environmental, social, and governance (ESG) issues are becoming a top priority for mutual fund managers and investors alike. More specifically, the focal point is how employers are addressing them.
Companies (including special purpose acquisition companies, or SPACs) that want to be included in mutual funds need to know that they’ll be under greater pressure to measure their ESG efforts. Failing to do so could result in share prices dropping, investors leaving, and the companies themselves being dropped from consideration for inclusion in mutual funds.
The Securities and Exchange Commission notes that “ESG investing has grown in popularity in recent years … ESG practices can include, but are not limited to, strategies that select companies based on their stated commitment to one or more ESG factors … for example, companies with policies aimed at minimizing their negative impact on the environment or companies that focus on governance principles and transparency.”
With regard to the social aspect of ESG, law firm Skadden points out that “the second half of 2020 continued to highlight the ‘S’ in ESG. Demands for greater gender and racial diversity at management and board levels resulted in many large U.S. corporations pledging to report on their diversity, equity and inclusion (DEI) figures in an effort to increase transparency, and many companies working to improve their board diversity.”
So where do mutual fund managers come in? Institutional Investor reports that “asset managers are funneling resources into making sure their investments live up to their ESG promises.” Ernst & Young writes that “mutual funds play a central role in pushing companies in which they invest to manage ESG risks and seize related opportunities. As intermediaries, they have to offer ESG products and services to meet evolving customer and investor needs. As fiduciaries, they have to mitigate ESG risks.” And a Lexology writer adds that ESG issues will “shape the evolution of how fund products are developed, distributed and managed … sustainable finance and ESG are likely to continue to dominate the landscape for the coming years.”
Investors themselves are demanding more information and transparency regarding the mutual funds they choose. Morningstar offers investors a sustainability rating for mutual funds that allows them “to understand how the companies in their portfolios are managing their ESG risks relative to their peers. This rating is built to enable advisors and investors to directly compare companies across industries, and … make investment decisions.”
It’s worth pointing out that selecting ESG-friendly funds is increasingly rewarding investors; in 2020, “U.S. sustainable equity funds outperformed their traditional peer funds by a median total return of 4.3 percentage points,” according to Morgan Stanley.
Now more than ever, it’s crucial for companies to be more proactive about ESG matters. Forbes notes that “From a company’s perspective, failure to rise to the challenge of improved reporting means that investment may find its way elsewhere, to competitors that can satisfy growing ESG demands.”
The National Law Review recommends, “in light of the enhanced focus on ESG issues and the potential risk they pose, companies should begin to take steps now to ensure compliance and avoid litigation, including … updating risk assessments to review company-specific ESG risks and the effectiveness of policies and internal controls designed to mitigate risk. The risk assessment should evaluate not only legal risk, but also potential reputational harm.”
Companies that have the metrics to back up their ESG efforts will fare better under increased scrutiny from mutual fund managers and investors. One such metric is pay equity, which is strongly interconnected with the social aspect of ESG, particularly issues surrounding DEI.
Trusaic’s PayParity DEI monthly monitoring platform provides a path forward for companies’ DEI, hiring, retention, and promotion analysis goals.
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