Environmental, social, and governance (ESG) investors are expected to focus on finding new approaches to social inequality issues in 2021 as the traditional approaches to dealing with social inequality within the ESG framework have been shown by the pandemic to be inadequate. As a result, investors are turning to the United Nations' Social Development Goals (SDGs) for direction.

They also have to take some risks as they search for new approaches to address social inequality issues since investment solutions for social issues are quite different from those for environmental and governance issues.

“A key challenge for investors lies in the tension between a desire for certainty that an investment will have the desired social outcome and the need to try new things in the time before clear definitions and assessment criteria can be developed,” states MSCI’s “2021 ESG Trends to Watch” report. “Investors are not always clear as to what is a legitimate socially beneficial offering and what might actually be “social washing”.

Before the pandemic, investors’ go-to lever on social issues has typically been to engage individual companies to change their practices, but that may not be enough when the problem is systemic.

Some of the new approaches to addressing a challenge – which extends beyond the neat boundaries of individual companies – that are being considered involve financing vehicles, such as social bonds.

MSCI, however, warns that finding truly innovative solutions for addressing and financing social issues within the ESG framework will require investors to have the willingness to risk a few failures along the way. “We see a lot of fear among institutions that they might unwittingly finance the latter. But, if that fear yields paralysis, then bold, large-scale solutions will remain untried.”

“Covid-19 has put its thumb on the top 1% side of the wealth scale, undoing decades of progress toward greater (social) equality,” according to the MSCI report. “The toll can be counted in lives lost, economic pain and instability. The conventional investor toolbox, however, has never been well equipped to tackle social inequalities.”

Research indicates that the “S” in ESG is different from governance and environmental issues. For example, the governance problems of companies tend to materialize during negative events, such as scandals, resignations or major drawdowns. On the other hand, poor environmental risk management can manifest itself in a gradual erosion of a company’s competitiveness and stock price value.

But when a company encounters social issues, such as workforce management, they can get hit from both sides with periodic negative events like lawsuits and strikes and the gradual erosion of productivity and stifled innovation.

“Company action is important, but there are limits to what individual firms can do to address the underlying root causes of inequality,” according to MSCI. “As long as the root causes remain, the inequalities and the risks remain too. We see investors waking up to that reality and beginning to shake things up.”

First, some investors have been turning to the UN’s Sustainable Development Goals (SDGs) as a framework for developing their approach to addressing inequalities.

Though only SDG 10 (reducing inequality within and among countries) explicitly addresses inequalities, many of the other goals target related issues like poverty (SDG 1), hunger (SDG 2), health (SDG 3), education (SDG 4), gender equality (SDG 5) and decent work (SDG 8).

“Whether the motivation is risk mitigation or a sense of justice, more investors are looking at their portfolios’ net alignment, whether positive or negative, with each of these SDGs as a first diagnostic of where they may be falling short and where they could have the most impact,” MSCI notes. “Some may decide that a targeted focus on a specific SDG, such as decent work (SDG 8), is a cornerstone of the progress that private capital can feasibly achieve, rather than a more scattershot approach.”

Second, over the past year, there has been an explosion of social bond offerings, many of which have focused explicitly on mitigating the negative impacts of the pandemic.

Early signs reveal investors’ growing appetite for these instruments. In October 2020, for example, the European Union issued 17 billion euros in social bonds, the largest-ever social bond issuance to date. They were aimed at providing pandemic relief, and explicitly tied to SDG 3 (good health and wellbeing) and SDG 8 (decent work and economic growth). The offerings were heavily oversubscribed.