Three ways social considerations can enhance portfolios

Over the last decade, the financial materiality of sustainability considerations — often regrouped under the acronym ESG — has steadily moved up investment agendas. Historically, investors have directed their attention mostly to environmental (E) and governance (G) concerns. However, key developments, notably deglobalisation, greater focus on labour relations and supply chain management, AI and the need for a just net-zero transition, all point to the growing financial materiality of the social (S) dimension. Applying such a lens can help investors assess companies in areas that are increasingly vital to long-term success, such as corporate culture and supply chain management. We have also observed that in certain circumstances, social themes may serve as an additional diversifier. For instance, companies in areas such as education have historically displayed defensive qualities.

In 2023, Wellington held over 17,500 meetings with more than 5,500 public-market issuers,¹ covering an array of topics, including social themes. The outcomes of these discussions enrich the wider research mosaic that investment teams across the firm leverage. They also help inform our proprietary ESG scores, our research on the risks and opportunities of a just net-zero energy transition and our anti-modern-slavery framework. Our 2023 tracked engagements also reflect the growing importance of social topics (Figure 1). 

Figure 1

Social factors are a critical part of Wellington’s engagement activity

Tracked engagement by category

Against this backdrop, we set out three specific ways to translate social risks and opportunities into the potential for greater and more sustainable returns. The three avenues we explore take distinct directions — adopting a stewardship, thematic and impact perspective, respectively — but all share a focus on active management and engagement.

Stewardship investing

In our view, stewardship always has a strong social component as we consider responsible and strategic management of natural, human and financial resources as an essential prerequisite to creating lasting value. Companies that consistently balance the needs of all stakeholders to the benefit of people, planet and profit are, in our view, best placed to maintain market leadership and deliver superior profitability over the long run. The long-term nature of stewardship investing — with names typically held for at least a decade — also means that proactive engagement is critical. Social topics are a major agenda item during these discussions. 

Case study: supply chains and responsible sourcing

Global supply chains often constitute a blind spot for companies and investors alike, yet recent disruptions have demonstrated how extracting maximum efficiencies from sourcing and inventory management has created unintended vulnerabilities and reputational risk. We therefore look for solid evidence that portfolio companies are proactively addressing these risks and building more resilient and sustainable supply chains. For instance, we approached:

• A leading tyre manufacturer to explore sourcing risks associated with natural rubber. We learned that to help trace its complex rubber value chain, the company developed its own mobile app, which aggregates stakeholder information about farming practices. It has already gathered information from over 42,000 rubber tree farmers on issues including working conditions and child labour practices. The company widely shares this app and the data to help drive improvements across the industry.
• A fast-fashion retailer to discuss modern slavery concerns. We established that the company had the necessary risk controls and oversight but encouraged management to provide more supply chain transparency and accountability.

Thematic investing

Another lens through which to capture social risks and opportunities is to focus on long-term next-generation themes, many of which have a strong social aspect. By bringing into play a wide range of research perspectives from different teams across our core themes of innovation, sustainability and inclusion, we believe it is possible to determine likely winners of these structural social trends and build diversified portfolios with attractive risk/return potential. 

Case study: innovation in health care 

Recent advances in science, tools and technologies are paving the way for treatments that are more effective, more precise and have fewer side effects. We see particularly promising developments in medical technology (medtech) and biotechnology (biotech). These innovations could deliver major medical and social benefits, such as better diagnosis and treatment. On the flipside, they also raise new ethical and social questions. Provided these concerns are addressed, we think the market for innovative technologies and therapies could create significant opportunities that thematic investors could be well placed to exploit. Examples of opportunities we have identified include:

• A medtech manufacturer — As one of the world's leading medtech providers, this company offers products across a range of areas, including orthopaedics, neurotechnology and medical and surgical equipment, which help deliver significant medical but also social benefits by improving the success rate of diagnostics and procedures and by widening access to complex treatments. The company is experiencing robust growth thanks to a number of new innovations and strong demand for patient procedures. 
• A biotech specialist focused on autoimmunity — Autoimmune diseases are triggered by malfunctioning immune systems that attack healthy tissues in the body. These diseases represent a growing medical challenge. For instance, a recent study estimates that in the UK, autoimmune diseases affect approximately one in ten individuals.² As well as causing significant suffering, they also hamper people’s ability to participate fully in society. More effective treatment options therefore may deliver both medical and social benefits. The solutions being developed by this biotech company are a case in point. It specialises in antibody engineering in order to create new treatment options for patients afflicted with ulcerative colitis, an autoimmune disease affecting the large intestine.

Impact investing

An alternative avenue is to invest explicitly with a dual objective, targeting both competitive financial returns and measurable positive impact. We believe that by investing in solutions that address some of the most pressing global challenges, many of which have a strong social dimension, we can provide a highly additive approach that: 

• provides exposure to sectors and companies/issuers across developed and emerging markets that may not be captured by more traditional ways of investing; 
• enhances a portfolio’s overall stability through diversification; and
• offers measurable positive societal impact in areas such as education, affordable housing, clean water, financial inclusion and health care.

In our view, diversification can be enhanced further by impact-related fixed income investments as they allow investors to target promising areas — mostly not captured by public equity markets — across the full fixed income spectrum, from municipal to corporate bonds, and from government agency to social government bonds. Fixed income offers the additional benefit of being able to deploy capital at scale in response to immediate environmental or social challenges. 

Case study: education 

Education and job training is a key area for social impact. Solutions for improving in-person teaching and expanding remote-access education, especially for low-income populations, can have positive multiplier effects that may be widespread and enduring. We see this theme as an important diversifier as certain areas of education have historically demonstrated defensive qualities. We think attractive opportunities include:

• A for-profit health care educator, which facilitates access to quality medical training and education for demographically challenged and traditionally underserved student populations. We believe this provider is well positioned given persistent labour shortages in the health care sector. We are also impressed by its partnerships with universities globally to truly understand what is most important for students and what skills are in demand in the jobs market. From a portfolio construction perspective, the stock may offer countercyclical benefits as for-profit education is historically “defensive” in recessionary environments.
• An unemployment insurance agency, which helps unemployed people reintegrate into the workforce by providing financial support and job training programmes. We think this European agency’s social bonds offer the potential for both attractive returns and measurable social impact by enabling the agency to fulfil its role as a social safety net and provider of dedicated reintegration programmes for job seekers. 

Bottom line

We think that an active focus on social risks and opportunities can help investors build more robust and diversified portfolios that benefit from exposure to the most innovative companies and issuers. We have identified three main avenues for capturing the attractive return and sustainability potential associated with social investing. In our opinion, they provide tangible examples of how the inclusion of social considerations can materially enhance traditional core portfolios.

¹Source: Wellington. For illustrative purposes only. Data represents meetings with public-market issuers as of 31 December 2023. “Issuers” refers to companies and sovereigns. For the Wellington Management group of companies. While all meetings inform our investment processes, ESG topics are not covered at every meeting. | ²Nathalie Conrad PhD et al, “Incidence, prevalence, and co-occurrence of autoimmune disorders over time and by age, sex, and socioeconomic status: a population-based cohort study of 22 million individuals in the UK”, The Lancet, 3 June 2023.