To stay on the cutting edge of environmental, social and governance integration, institutional investors have to expand their focus beyond the factors that are material to a company’s operations today and look ahead at what’s around the corner.

According to a report by the World Economic Forum, this is becoming an integral part of investors’ analysis. “To win in the coming decade, investors and companies must equip themselves with forward‑looking and proactive approaches to materiality,” it noted.

Many investors are already developing these capabilities, preparing them for the added challenge of dynamic materiality, the report said. As ESG increases in relevance, institutional investors are bringing strategies in-house and completing their own analysis of which issues are material to a company rather than using third parties. As well, ESG analysis is becoming part of the average portfolio manager’s tasks, rather than a specialized research area.

Read: Institutional investors increasingly see ESG as source of alpha: survey

In addition, the report noted companies are being increasingly pressured to provide unprecedented levels of transparency around the rate at which new factors become material to them. The#MeToo movement is a prime example of how an issue that went largely ignored was suddenly thrust into the limelight.

“In a hyperconnected world, one in which information can be disseminated widely and immediately, movements such as #MeToo can emerge and achieve scale rapidly, creating legal, branding, recruiting, retention and other challenges for any company whose policies against harassment and discrimination are inadequate,” the report said.

While many companies are initiating plans to improve performance based on relevant sustainability factors, the next logical step is to begin initiatives based on which factors are likely to become material down the line.

Read: Where should institutional investors target engagement in 2020?

But identifying the most important forward-looking factors will be a challenge for companies and investors alike, noted the report. First, stakeholders have to examine the environmental and social impacts of corporate practices. Three key elements are making those impacts more important — emerging scientific evidence around ESG issues like air pollution or single-use plastics; better and broader data around these issues; and the massive speed with which information can now circulate.

However, widespread knowledge of a positive or negative externality doesn’t automatically mean it translates into a material issue for a company, said the report. “The second stage in the process, when evidence triggers materiality — sometimes in a matter of days — comes when stakeholders (including, sometimes, shareholders) apply evidence in a way that causes a significant change in societal expectations. In recent years, the ability of stakeholders to use evidence to affect business value has been growing.”

Non-government organizations and other activists have become more powerful influencers, while policy-makers are reacting to that pressure, as well as mounting evidence. In addition, consumer sentiment can shift rapidly in today’s environment. In light of all of this, the report said investors must also examine the responsiveness of key decision-makers within companies.

Read: How ESG factors play into alternative investments

Copyright © 2020 Transcontinental Media G.P. Originally published on benefitscanada.com

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