Environmental, social and governance (ESG) research among institutional investors has historically focused mostly on the “E” and the “G,” leaving social issues as something of a forgotten middle child. Investors have concentrated on quantifiable environmental targets such as carbon emissions. When it comes to best governance practices at corporations, they’ve focused on compensation and board composition. But social investment risks—especially risks related to racism and racial injustice—have often taken a back seat.
There are several reasons institutional investors have likely de-emphasized social issues in their research. Social matters seem abstract, and they are often broadly intertwined with our societal fabric, which makes it very difficult to develop a quantitative model for understanding how these matters impact corporate performance. Additionally, there is an undeniable disconnect between the demographics of typical institutional investors and the people harmed by the externalities of some investments.
But we believe that a company’s social attributes are material investment factors. They offer risks and opportunities on their own, and they are often inextricable from environmental and governance matters. We have seen this intersectionality play out very clearly in 2020. The story of the Covid-19 pandemic and the powerful reaction of society against police violence have developed in a highly interrelated matter. This has forced international attention on links in social and environmental justice that the Black community in the U.S. and other marginalized populations have long understood. It is just one of many reasons we believe that E, S and G issues need to be evaluated in concert with one another, not in isolation.
Investment And Justice
As humanity’s technological and industrial footprint has expanded, our impact on the world has intensified, and our actions in one place can have meaningful impact in other places. This is the basis of environmental justice, a concept that can play out both globally and locally.
The U.S. is the second-largest carbon-emitter in the world next to China. It plays a meaningful role in determining the fate of many low-lying island nations—countries that generally have miniscule carbon footprints but whose very existence above water is threatened by climate change. We believe an investment approach that seeks to avoid the destruction of nations is wise from both a moral perspective and a financial one, given the interrelatedness of the global economy. This is one of the reasons we seek to largely avoid investments in the world’s biggest corporate carbon emitters. Simply put, we think there are better investments on the table.
Domestically, we can look at the community of Port Arthur, Texas, for a stark example of environmental injustice. The city is home to the largest oil refinery in the U.S., and the surrounding area has been referred to as “the Cancer Belt” since the 1980s. Serious health conditions, including cancer, respiratory conditions and many other illnesses, run rampant in the city. The communities closest to the refinery predominantly include people of color, and their health is disproportionately affected. Texas Cancer Registry data from 2017 reported that Black people in Jefferson County, which includes Port Arthur, had cancer rates 15% higher than average Texans, and cancer mortality rates nearly 40% higher than the state average.
Notably, pre-existing respiratory conditions are a common result of living near facilities such as refineries or hazardous waste facilities, and those circumstances are also a key indicator of survival for those infected with Covid-19. This is all part of a broader mosaic in the U.S. that systemically harms people of color. Black people in the U.S. are four times more likely to die from Covid-19, two and a half times more likely to die from police brutality and three times more likely to die from air pollution than white people.
These concepts can come into play in our investment decisions. Our fixed-income team recently passed on investing in bonds issued by a large city’s municipal water utility, for example. The team was not just concerned about water quality, but that the people at greatest risk of having contaminated water would be people of color.
Public Opinion Is Shifting, And It Matters
Issues perceived as “too political” can be divisive, and difficult to navigate. Climate change, the Covid-19 pandemic and racially driven police violence—these issues all have highly polarized stakeholders, and progress is slow as a result.
As long-term investors, we should remember that highly divisive issues can evolve into consensus viewpoints in the not-so-distant future. Climate change stands out as an example of this concept. In 2010, the materiality of climate change risk was still widely debated in political and corporate circles. Yet today, the corporate world has largely come to agree that climate risk is dangerous, and that it’s good business to try and mitigate that risk. We believe this was driven at least in part by ESG research practices that consistently looked at climate risks through an investment lens; looked at the cost/benefit of climate resilience measures being considered by companies and governments; and, importantly, identified companies poised to expand existing businesses or create entirely new ones based on the growing customer demand for solutions to reduce energy, water and other resource usage. To a meaningful extent, company and issuer action on climate change has become the expectation, not the exception.
Climate change and racism are not identical issues. Rising sea levels are scary, but they do not force us to look in the mirror and confront our society’s prejudices and systemic biases. But climate change is increasingly understood as a risk to investments, health and justice, and we view social issues like racism in the same manner.
We think one clear factor investors need to consider is the racial diversity and progressiveness of Generation Z, which accounts for 40% of consumers as of 2020. This generation has high expectations for companies to address sustainability and social responsibility. They want to work for businesses and buy products that reflect their diversity and inclusiveness, and companies are going to need to meet this generation’s expectations to attract their talent and dollars. Approximately 90% of Generation Z supports Black Lives Matter, and brands that do not clearly articulate anti-racism efforts risk losing this cohort as customers or colleagues.
What We Are Doing As Investors
Deep-seated social inequities such as systemic racism cannot be fixed with a single approach. Efforts on multiple fronts are needed to fully realize the vision of “liberty and justice for all.” In addition to the political and civil debates occurring across the U.S., we believe that investors can and will play a role, and that companies and bond issuers will be held increasingly accountable for the impact they have on their colleagues, communities and customers.
Our firm’s ESG research process seeks to dynamically respond to complex problems. For many years, we have used this process in an effort to examine a wide range of factors that we believe influence an issuer’s or a company’s long-term health and prosperity, such as employee treatment, customer care, health and safety, and other responsible management practices. These factors are always meaningful for issuers and companies, and social issues such as the Covid-19 pandemic and racial inequality simply reinforce just how important these factors are.
We will continue to approach social issues, like racism, through ESG and fundamental research integration, proxy voting, and direct engagement with companies and bond issuers.
Engagement: We are actively promoting racial justice under our firm’s three primary 2020 engagement priorities: diversity, climate change and artificial intelligence ethics.
Diversity: By engaging with companies and issuers on diversity and inclusion, we can encourage them to increase their representation of diverse identities—not just because it is the right thing to do, but because it is also good for business (for example, companies with above-average diversity scores are nearly 20% more likely to have increased innovation revenue than companies with below-average diversity). We can also encourage structural transformation to support racial justice. For example, we can invest in municipal bonds that seek to ensure people’s equitable access to essential resources and services, like affordable housing, public transit and education.
Climate change: We can encourage businesses and communities to address climate change mitigation and understand the damage climate change causes, knowing very well that it will affect communities of color disproportionately.
AI ethics: Our engagements focused on responsible artificial intelligence ethics and data privacy are aligned with our focus on anti-racism. Surveillance technology is often embedded with the human bias of those who program it, so it is not entirely surprising to find that technologies such as facial recognition are less accurate for people of color. A landmark 2019 study found that the majority of the algorithms in use across the U.S. showed worse performance for nonwhite faces than white ones—in some cases, much worse. Another study showed that one technology confused a number of black U.S. lawmakers with criminals. AI ethics is still an evolving topic, however, and the technology is also bound to play a material role in upholding human rights in the future. We have been in dialogue with the leading companies producing artificial intelligence and making decisions about data privacy for the last two years. We were encouraged by the actions several companies took in the wake of police brutality protests in 2020. Several large technology companies will limit the use of their facial-recognition systems going forward and will not sell the controversial technology to police departments until there is a federal law regulating the technology.
Proxy voting: Our engagement approach includes proxy voting. As investors, we vote in favor of shareholder proposals that encourage diversity at the companies we hold and discourage institutional racism. For example, our firm voted in favor of a recent shareholder proposal at a company that called on it to evaluate its environmental impact on communities of color. We cast our vote even though our proxy voting service provider recommended we vote against it.
Investment choices: We want to avoid investments that worsen racism and favor those that are working to solve for it. The companies we look to invest in receive high marks for diversity and inclusion, and we consider bonds from issuers expanding access to basic human rights like clean water. In this effort, we study the metrics of employment representation, pay parity, the accessibility of products to communities, companies’ arbitration policies, health and safety records, and how the companies and issuers are affecting the communities in which they operate.
Marginalized populations have suffered for many years from racial violence, unequal access to public health, the disproportionate impact of climate change and many other injustices. These societal challenges are not new, and we expect them to grow in importance and materiality. At Brown Advisory, we are focused on using this global inflection point to further strengthen our commitment to diversity and equity. We have taken many of the actions we ask of companies and issuers—such as improved disclosure, goals for hiring and promotion, and the formation of a racial justice task force. There is more to do. And we will hold companies, bond issuers and ourselves accountable.
Katherine Kroll is a senior institutional sustainable investing specialist at Brown Advisory.