Part 1: Overview of the ESG Landscape (“Setting the Stage”)
Overview of the ESG Landscape ("Setting the State") notable events and key developments over the past year that have shaped the landscape as it exists today
As we approach the summer – one that looks vastly different than what we collectively experienced just one year ago – we are taking the opportunity over the next four weeks to follow-up our inaugural 2020 ESG miniseries and provide an update on the ESG landscape and insights into investment trends, buy side approaches and company communications, including common and emerging practices.
- Overview of the ESG Landscape (“Setting the Stage”): Notable events and key developments over the past year that have shaped the landscape as it exists today
- Primary Research on ESG: Buy side perspectives
- Corporate Perspectives and ESG Communication Practices: Including how companies are communicating their ESG journey
- Executive Summary: Best practices and recommended strategies for effectively communicating your ESG journey
Setting the Stage
As we strive to “cut through the noise” and provide our clients with practical insights into this complex landscape, we’ve distilled a year’s worth of ESG news down to the most important updates. But before getting into key trends, let’s set the stage.
Based on tracking buy side views for over a decade, we have seen investors increasingly incorporate ESG into their investment decisions. According to our proprietary research, 9 out of every 10 investors globally incorporates ESG into their investment decisions to some extent, including more than 4 of every 10 noting ESG is Very Important or Critical. This is more than double 2010 findings.
Sustainable Fund Flows – Continuing to Set Records
In 2019, net flows to ESG funds in the U.S. topped $20 billion, compared with slightly over $5 billion the year prior and more than four times the amount in 2018. In total, sustainable mutual and ETFs held $137.3 billion in total assets at the end of 2019.
Continuing this trend, in 2020, flows reached $51.1 billion in the U.S., with $20.5 billion of that coming in Q4 alone. In total, there is now $1.7 trillion in global ESG fund assets, with Q4 seeing a 29% increase. In the first three months of 2021, the U.S. sustainable fund landscape saw nearly $21.5 billion in net inflows, suggesting 2021 will be yet another record-breaking year for sustainable investing in the U.S. and abroad.
Even more, in 2020, sustainable equity funds significantly outperformed relative to their traditional fund peers. Three out of four placed in their category’s top half, and far more sustainable funds ranked in the top quartile (42%) than in the bottom quartile (6%).
There’s a lot of capital out there looking to support companies that are committed to ESG and to making a positive impact.
ESG – A Dynamic Year in Review
To summarize key events that shaped the last year and played a significant role in driving ESG fund flows, below is a timeline of the last 12 months.
2020
2021
Spotlight on Social
Since our last ESG miniseries and following the SEC’s amendments to “modernize” disclosures of business, legal proceedings and risk factors under Regulation S-K, our September 2020 Inside The Buy-Side® Earnings Primer® survey found – for the first time ever – investors identifying talent management among the top five topics of interest on earnings calls, followed by one-third noting HCM as the top focus area for Social heading into 2021 as published in our January 2021 Earnings Primer®.
As the construct of HCM evolves, with trailblazing public companies proactively and transparently communicating facts and figures about what they are doing to keep their employees safe, engaged, innovative, and happy, investors focused on ESG – a rapidly growing number – will seek increased disclosure across their portfolio, as they have done with the ‘E’ and ‘G’ sub-factors.
In an early look at an analysis of the S&P 500, in partnership with the University of Connecticut (Go Huskies!), we found 91% of companies discussed HCM in annual reports and 76% in proxy statements. The following are the most common focus areas throughout issuer communications.
Diversity, Equity and Inclusion (DE&I)
Increased awareness of social and racial inequities, brought to a head following the death of George Floyd and the resurgence of the Black Lives Matter movement, has contributed to increased conversation at the corporate level about diversity, equity, and inclusion. From what we consider one of the most powerful charts of 2020, more than 300 companies globally discussed racial inequality and social injustice on earnings calls in the fall.
The 2021 proxy season is shaping up to be historic, with a record number of shareholder proposals related to diversity disclosure. As of April 6, shareholders have filed 69 shareholder proposals urging companies to disclose the diversity of their workforce and information on retention and promotions, more than twice the number filed last year (32).
Aeisha Mastagni, portfolio manager at California State Teachers Retirement System (CalSTRS), which manages $289B, said, “CalSTRS is no longer debating the issue of whether or not diversity adds value to a company… there’s so much evidence and academic studies that show diversity adds value that we’ve gotten past the debate and gotten to what companies are trying to do to move the needle.”
As stakeholders demand more information related to HCM, companies are responding in a variety of ways in terms of how they measure, disclose, and set goals related to DEI efforts. While a step in the right direction, the SEC’s November rule change to Reg-SK created confusion, as it gave companies broad leeway to determine which details were required for disclosure.
A trend we’re following is an expansion of what is included within ‘D&I.’ What started as ‘Diversity & Inclusion’ has since grown to include ‘Equity’ and more recently, ‘Belonging.’ This expanded definition suggests it is more than just about hitting quotas but instead, an increased focus on making workers feel like a part of a cohesive community. Engaged employees contribute to a positive corporate culture, which is an important component of operational excellence. In an analysis of 32 companies with codified operating models, we found a growing number, 22%, now tie operational excellence to Purpose. Prior, it was just 6%.
If your company has not yet strategized on how to best manage, measure, and disclose information related to HCM, now is the time to develop a formal approach, as the stakes are higher than ever and disclosure requirements will likely become more uniform over time.
To spur thought, here are a few examples of how companies are thinking differently about Diversity, Equity & Inclusion:
- Bank of America (NYSE: BAC): published its second HCM Report in 2020. The report goes into extensive detail on workforce metrics, including year-over-year comparisons of representation of women and people of color in various levels of seniority across the organization, pay equity data, recruitment efforts to facilitate a diverse pipeline of talent, and new, enhanced employee wellness benefits as part of retention efforts.
- Verizon (NYSE: VZ): released its inaugural HCM Report last month, which includes detailed information about pay equity, the makeup of its global workforce, and details on its initiatives to attract and develop employees. The report also includes gender and racial/ethnic diversity data globally and by business segment.
Health & Safety
The pandemic forced companies to think differently about employee health & safety. From managing essential workers and providing ample personal protective equipment (PPE) to COVID-related benefits, some companies were creative in finding new ways to provide support to their employees. Here are a few notable examples:
- United Therapeutics (NASDAQ: UTHR): Implemented a $1,000 pre-tax stipend for supplies or self-care for employees working from home, as well as four months of daily take-home dinners (up to 4 per employee, to accommodate for family members) for all employees who were required to report to a physical facility for work
- Home Depot (NYSE: HD): Provided an additional 80 hours of paid time off for full-time employees and 40 hours for hourly associates (paid out if not used), unlimited emotional and mental health counseling visits, and temporary COVID-19 benefits, which became permanent starting in FY Q3’20
- PepsiCo, Inc. (NASDAQ: PEP): Gave caregiver benefits – employees caring for a family member with COVID-19 received 100% of their pay during the 14-day quarantine period; after that, employees who had to continue to give care and were unable to work from home received two thirds of their pay for up to 10 weeks, while employees impacted by school or day care center closures received two-thirds of their pay for up to 12 weeks if they were unable to work from home while caring for a child also at home
Spotlight on Climate Change & The Road to Net Zero
There is no question: the world is in the midst of a serious climate and biodiversity crisis. A 2020 report from the World Wildlife Foundation found that global populations of mammals, birds, fish, amphibians, and reptiles plunged by 68%, on average, between 1970 and 2016 and some scientists have warned we are entering the sixth mass extinction.
Beyond the tangible consequences to our planet, just yesterday the director of the IMF’s Monetary and Capital Markets department, Tobias Adrian, said, “The climate crisis could absolutely ignite a financial crisis.” Even with an almost 7% decrease in global greenhouse gas emissions in 2020 (due in large part to the pandemic and travel-related restrictions), the U.S. still didn’t reach the emissions progress is being made.
Increasingly, more companies are committing to net zero carbon emission goals to curb climate change and slow the warming of Earth. At the end of March, 21% of the world’s 2,000 largest public companies had committed to meet net zero targets. Net zero includes, commitments to:
- Not add new GHG emissions to the atmosphere
- Reduce emissions or balance them out through carbon offsets (where GHG emissions are removed from the atmosphere through forests and oceans that absorb carbon); carbon capture and storage (CCS, where CO2 is removed from factory chimneys and pumped underground or stored in a solid form); and/or carbon capture that collects CO2 directly from the air (requires less land than CCS but is still energy-intensive).
Another issue of growing importance related to climate change is the measurement and individual disclosure of Scopes 1, 2 and 3 carbon emissions. As this is an increasingly important area of disclosure, we want to explain the intricacies:
- Scope 1 and 2 Emissions: Refer to a company’s emissions from direct operations and purchased electricity and power; these can often constitute a very small portion of total emissions
- Scope 3 Emissions: Come from indirect sources and can often be the largest GHG contributor, as they represent the emissions up and down the value chain
We expect to see more and more companies measuring, disclosing, and setting goals related to Scope 1 and 2. Scope 3 disclosure requires more detailed intelligence of emissions along the value chain, making it significantly more challenging to effectively disclose. And while there are questions about the comparability and verifiability of these emissions – for instance, Apple’s Scope 3 disclosure includes emissions from employee commutes while Amazon’s only includes employee commutes that use the company’s shuttle – companies must advance on this journey to help achieve emission reductions goals collectively.
As ESG-related environmental metrics are only becoming more complex and disclosure more robust, many companies are proactively engaging in discussions with suppliers, vendors, and customers to obtain a holistic picture of their GHG emissions and we encourage our clients to get ahead of this trend as it’s not a fad.
In Closing
ESG is a rapidly evolving landscape that will continue to change for the foreseeable future. We maintain our data-driven view that companies committed to ESG, and sustainability more broadly, will be winners over the long haul – both in terms of attracting and retaining top talent, winning business, and outperforming the equity markets.
Our goal in sharing our research, insights, and recommendations with you over the next four weeks is to simplify the complexity that is ESG, arm you with actionable information and inspire you to drive positive change at your organizations, and help you capture investor attention and mindshare as you advance on your ESG journeys.