An important, but overlooked task
When we mention and analyze “ESG” within an investment environment, we believe strongly that it is wrong to ignore the “S” Social component as it has long term financial materiality. In this short paper we explore important and often overlooked task in detail. S is an integral part of the “ESG” acronym. Within the three components of ESG, it is fair to say that, within the real estate context, whilst environmental and governance aspects are progressively well covered, the S still largely remains in the background, from a global standpoint. The inclusion of the S component is very important due to its financial materiality, but is also very challenging, as it attempts to incorporate market practices into what traditionally has been considered a more political area.
Social as an investment valuation factor
From an investment theory standpoint, VLK’s Real Estate team treats the Social factor as another of the several performance factor variables that we can analyze and eventually exploit for mispricing in an active management environment. The Real Estate team analyzes four high level factors to generate risk adjusted outperformance or “alpha”. A proprietary data model to feed our fundamental bottom-up real estate models is then utilized to gain an edge on location and building quality. This is referred to as the valuation of the investment and is the first return investment factor. Additionally, the team analyzes a company’s management team acumen, the balance sheet and the ESG performance of a company which are the three remaining investment risk factors. These latter factors are referred to as the risk of the investment. It is in this latter context that the Social factor enters the Real Estate team’s investment process quantitatively.
All else equal, for a given valuation of a certain collection of assets, we are willing to pay a higher price for a company with stronger Social policies than one with weaker ones. This goes for all the other factors that we listed which constitute the risk of the investment. In short, lower risk warrants a higher price.
Social factors as an engagement tool for change
In addition to creating investment alpha, just as important is the second essential pillar of active investing. Namely, that is the continuous engagements for positive change. The social framework allows us to have precise tools for implementing stronger social practices. Having designed a quantitative score which builds up from many moving numerical parts, we can zoom-in on the precise points of attention of social practices that we would need to see changed. We can also showcase precisely how the valuation of the investment would change based on our models, and ultimately the size of the potential increase in investment value that we could make should the companies implement better social practices.
The Social stakeholders in scope – the Social value chain
Before we dive into the precise categories of social improvement we need to establish who and what this framework affects. Mainly, the focus categories cover a company’s own workforce, the workers in the value chain, the affected communities and the end consumers or tenants. Ultimately the Social aspect is all about people. In line with the forthcoming European Sustainability Reporting Standards, we have tailored our framework to have as wide of an impact as possible.
The Social framework focus categories
After a deep review of academic literature, data vendors, and interviews with our investee companies we have come up with numerous social areas that we believe require evaluation to measure ultimate progress of a companies’ social practices. We settled on the following three overarching focus categories. These are: Security, Inclusion and Resilience.
Security contains a wide array of themes. It encompasses everything from the physical security of a building or asset and the community it operates in, to the cyber security policies of a company and even the financial security policies offered towards tenants. The better a company does across the value chain to contribute to security, the more likely it is that they will contribute to the resilience of the communities it operates in and equally as importantly, its own competitive place in it, for the long-run.
Inclusion: Inclusion and diversity is extremely important in building a future proof business. This category is often as broad or narrow as the societies a company operates in and the clients it serves. We focus on the inclusion and diversity across the whole organization and not only at board level. It is difficult to hold a company to a global “best-practice” standard, however there are certain bare minimums that should be satisfied for an inclusive and diverse company, in our view. The academic evidence is plentiful and quite precise on the performance enhancing element of a more inclusive company.1a In a real assets context, inclusion goes beyond the organization and also relates with how inclusive and cohesive a community is.
Admittedly, the third category is broad and abstract sounding. However, this is because numerous important themes sit within it. Resilience we define as the wellbeing of the workforce, the human capital development, the affordability and location resilience (e.g. green space) and the pollution/waste management policies. The American College of Occupational and Environmental medicine found links in long-term relative outperformance of companies with better health and safety programs than peers with less focus on this area.2 These categories, as ever, are measured across the full social value chain.
Summary and broader implications
The active investment management industry has a large say in the development of society. Investors can and should hold corporates accountable not only in the short term, but even more so over the long run. Whilst the rewards may not be immediate, ultimately we strongly believe that the benefit for the shareholders and the communities will be exhibited in the future. (for case studies please refer to the white paper). By focusing on security, inclusion and resilience across the workforce, supply chain, customers and communities, we believe have outlined tangible initiatives that companies can do to improve their own resilience and longevity as well as those of the societies within which they operate. Framing this list in an organized and quantitative way was never an easy task yet we believe we have been able to develop a constructive and forward looking social framework. The outputs have been sufficiently tangible and have begun to be integrated into our investment process as we continue to innovate and refine our investment process with more and better quality data. The responsibility as stewards of our clients’ capital has made it essential for us to dig as deep as possible in creating sustainable financial returns whilst simultaneously aiding society at large.
1. McKinsey Research, Diversity Matters, February, 2015
2. 2013 American College of Occupational and Environmental Medicine, The Link Between Workforce Health and Safety and the Health of the Bottom Line
Van Lanschot Kempen Investment Management NV (VLK Investment Management) is licensed as a manager of various UCITS and AIFs and authorised to provide investment services and as such is subject to supervision by the Netherlands Authority for the Financial Markets. This document is for information purposes only and provides insufficient information for an investment decision. No part of this presentation may be used without prior permission from VLK Investment Management.
Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested. Past performance provides no guarantee for the future.