Chap 4: Social Factors Flashcards
SOCIAL MEGATRENDS AND THEIR EFFECTS
Investors need to note the different social megatrends that could have an effect on the businesses of the investee companies.
This section looks at the **systemic relationships **
between these social megatrends and business activities of the investee companies, and elaborates on the material impacts of these trends on potential investment opportunities.
What are social megatrends??
Social megatrends are long-term social changes that affect governments, societies and economies permanently over a long period of time.
The megatrends that will be described in this section are:
A. Globalisation.
B. Automation and artificial intelligence (AI).
C. Inequality and wealth creation.
D. Digital disruption, social media and access to electronic devices.
E. Changes to work, leisure time and education.
F. Changes to individual rights and responsibilities and family structures.
G. Changing demographics, including health and longevity.
H. Urbanisation.
I. Religion.
Some environmental megatrends have a severe social impact as well.
These include:
▶ Climate change and transition risk.
▶ Water scarcity.
▶ Pollution.
▶ Loss of natural resources and ecosystem services.
All of these could, in an extreme case, result in mass ***migration.
These social megatrends will change the way we live, work, consume and perceive the world and, as such, will pose new risks or opportunities for investors. Next, we will look at each of them in further detail.
A. Globalisation
One of the biggest megatrends is the integration of local and national economies into a global (and less regulated) market economy.
This process is also called globalisation.
Globalisation is caused by a rapid increase in cross-border movement of goods, services, technology and capital. Depending on the viewpoint, it can be viewed as either a positive or a negative phenomenon:
▶ It has led and continues to lead to increased efficiency in the markets, resulting in wider availability of products at lower costs.
▶ It is claimed to be detrimental to social well-being due to social structural inequality, for example. Examples of its implications include:
▶ Offshoring. Due to the lower wage costs of workers in the garment industry in developing countries, clothes are now mainly produced in countries such as Vietnam, Bangladesh and China. This has led to the disappearance of the textile industry in Western countries. Offshoring also takes place in other sectors.
▶ Dependency. As US-based and Asian companies dominate the industry for mobile telephones, computers and other IT products,
*****European countries are more dependent on these suppliers.
B. Automation and artificial intelligence (AI)
Linked to the increased economic globalisation is the trend of automation, which is the technology by which a process or procedure is performed with minimal human assistance.
Some of the biggest advantages of automation in industry are that it is:
▶ associated with faster production and lower labour costs; and
▶ replaces hard, physical or monotonous work. The largest (social) disadvantage, however, is that it displaces workers due to job replacement, as technology renders their skills or experience unnecessary.
It is expected that this trend will increase due to the rise of AI.
AI is expected to have a significant effect on sectors such as:
▶ healthcare; ▶ automotive; ▶ financial services and auditing; ▶ security (including military); and ▶ creative (in particular, advertising and video games).
Implications for investors
The transportation industry is currently on the brink of becoming more automated, and it is expected that some jobs for drivers (of taxis, buses and lorries, for example) will disappear due to self-driving vehicles.
This will be beneficial for companies that develop the best self-driving cars, but less so for traditional heavy goods vehicle (HGV) companies that do not innovate.
One of the largest expected implications of this is that by automating the transport industry, major job losses will occur.
One possible solution is to invest in upskilling staff to enable their transition to a more AI-enabled world.
Investors should take this into account when assessing the risks of an investee company.
C. Inequality and wealth creation
The Organisation for Economic Co-operation and Development (OECD)i analyses trends in inequality
and poverty for advanced and emerging economies.
It examines the drivers of growing inequalities, such
as globalisation, skill-biased technological change and changes in countries’ policy approaches, and it assesses the effectiveness and efficiency of a wide range of policies, including education, labour market and social policies, in tackling poverty and promoting more inclusive growth.
According to the OECD Centre for Opportunity and Equality (COPE) 2015 report, the average income of the richest 10% of the population is about nine times that of the poorest 10% across the OECD.
This is also called economic or income inequality.
There is increasing evidence that growing inequality affects economies and societies.
Educational opportunities and social mobility may be reduced resulting in a less skilled and less healthy society with lower purchasing power among the lower and middle classes.
This limits total economic growth.
An issue related to the topic of inequality is corporate tax strategies and whether companies are too aggressive in their tax optimisation strategies.
As regulators put more focus on this issue, some companies (for instance, in the technology sector) have had to pay huge fines. Others will need to adopt more conservative tax strategies in the future that will impact their bottom line.
D. Digital disruption, social media and access to electronic devices
Another important social trend is the rise of digital disruption, which is the change that occurs when new digital technologies and business models affect the value proposition of existing goods and services.
This trend is closely related to the increased automation and rise of AI discussed in sub-section B above.
Some exemplary cases of disrupting companies include Amazon, Uber and Airbnb.
They have managed to enter an existing market, but with different and more digital business approaches than their competitors, and have managed to turn the existing business models around.
For investors who are about to invest, preferably at an early stage, in such companies, this can provide opportunities, although such investments can carry a high risk profile.
A related issue, as a consequence of digital technologies, is the huge amount of data that can be collected, stored and processed (big data), and the ownership or use of the data (including data privacy, monetisation of data, etc.).
The opportunity side of big data includes more personalised services, products and (health) treatments.
However, controversies have arisen because some data is being used and sold in more extreme or socially unacceptable ways; for example, by social media companies, such as Facebook, Twitter and LinkedIn (e.g. a political or marketing campaign, as seen in the case of Cambridge Analytica).
Due to these types of scandals, there is a debate around the growing need for regulating the industry. This can affect the profitability of these companies and should be considered by investors.
Finally, electronic devices are now found everywhere. Almost everyone, both in developed and emerging economies, owns a mobile phone (in many cases a smartphone) and a tablet.
The Internet of Things (IoT) is the next frontier, where semi-intelligent appliances (called ‘embedded systems’) communicate directly with each other and with the internet, and make autonomous decisions.
For investors, disruption represents both risks and opportunities.
Analysts need to take a forward-looking approach to determine which sectors and companies will thrive and which will struggle in a digital society.
E. Changes to work, leisure time and education
The way we spend our lives has changed dramatically over the last few decades.
Various measures have emerged that aim to provide a broad sense of the state of our societies and of how people’s lives are evolving.
The OECD examines issues of well-being in its Better Life Index, which rates a wide range of developed and emerging economies in a number of areas including life satisfaction.
Most countries in the developed world have seen average hours worked decrease significantly.
In the UK, the average annual hours actually worked per person in employment decreased from 1,779 hours in 1970 to 1,506 in 2010.
This is partially caused by increases in automation and part-time employment.
New technologies increasingly enable workers to be connected to their work from remote locations.
This creates an opportunity for employers and employees to adopt more flexible working patterns.
However, the constant connection also makes the notion of work–life balance more elusive and can cause stress-related illnesses.
Whilst the number of average working hours has decreased, the average level of education has increased.
The percentage of employees with a higher education degree has grown over the last few decades.
Yet, some sectors suffer from a lack of qualified employees and are facing an intense ‘war on talent’ to attract the most skilled workers.
Investors who are assessing companies that rely heavily on employees as a key asset need to pay attention to those companies’ human capital management strategies.
They should evaluate how the companies are coping with these structural changes in the labour market.
F. Changes to individual rights and responsibilities and family structures
In recent decades, not only has the way we divide work and leisure time changed, but also the role and importance of family (especially in developed countries).
People have more autonomy in making their own economic decisions (as opposed to those decisions being made by actors such as the state, the community or the employer).
Individuals are therefore less reliant on the family for (economic and physical) security.
The workforce has become more diverse: more women are now entering the labour market, which has provided women with more financial independence.
However, in comparison to men, women are still more likely to become and remain unemployed, have fewer chances to participate in the labour force and –
when they do secure employment – often have to accept lower quality jobs.
Women also face wage gaps in comparison to men.
To improve gender equality, a number of different initiatives have been created, and there is growing evidence that a more diverse workforce leads to better (financial) results.
Some best-in-class funds and impact investors take diversity (gender and other types of diversity) into account in their risk analysis and stock selection.
G. Changing demographics, including health and longevity
Due to improvements made in healthcare and changes in lifestyle, life expectancy is increasing.
For example, female and male life expectancy (from birth) in the UK increased by two years between 2002 and 2010 (to 78.4 years for men and 82.5 for women).
This increased life expectancy, combined with a falling birth rate, have caused many developed countries’ populations to age: the overall median age rose from 28 in 1950 to 40 in 2010, and is forecast to rise to 44 by 2050.
An ageing population has substantial effects on society:
▶ The ratio between the active and the inactive part of the workforce drops, impacting national tax revenues and challenging pension systems.
▶ Older people have higher accumulated savings per head than younger people, but spend less on consumer goods, which is a business risk for some industries.
In some categories, such as healthcare, expenditure rises sharply when populations age.
H. Urbanisation
The places where people live also change. Increasingly, the population has been shifting from rural to urban areas.
In the 1950s, approximately 30% of the world population lived in an urban environment. This is expected to increase to 65% by 2050.
This can have different kinds of implications for societies, including the following:
▶ Economic: dramatic increases and changes in costs, often pricing the local working class out of the market.
▶ Environmental: the existence of ‘urban heat islands’, where urban areas produce and retain heat, becomes a growing concern.
▶ Social: increased mortality from non-communicable diseases associated with lifestyle, including cancer and heart disease.
Residents in poor urban areas (such as slums) also suffer “disproportionately from disease, injury, premature death, and the combination of ill-health and poverty entrenches disadvantage over time.”
These societal implications provide business opportunities because of the growing need for infrastructure development, but also require companies to address social and environmental issues related to urban living (for instance, pollution and waste management systems).`
I. Religion
Religion can have an effect on investment decision making.
A distinction should be made between exercise of religion as a social factor and faith-based investing.
As a social factor, the changing religious landscape around the world has consequences for consumer preferences.
Religion-based politics and conflicts can also have a profound impact on specific local economies.
All investors (faith-based or not) should therefore judge if investee companies take these changes into account from a financial perspective.
Religion can also play an important role in investors’ norms-based preferences. Faith-based investors aim to invest their money in line with a specific named faith, and the two most common types are:
▶ Christian investors, who aim to align their investment principles to the Bible, which means that they may refrain from investing in firms that support abortion, contraceptives, embryonic stem-cell research, weapons of mass destruction, tobacco, alcohol and pornography.
▶ Islamic investors, who are looking to invest in line with Shariah principles, also would not invest in companies that profit from alcohol, pornography or gambling, and also exclude companies involved in pork.
They will not own investments that pay interest or invest in firms that earn a substantial part of their revenue from interest.
Norms-based exclusion has been one of the first ESG investing instruments and many of these first movers were faith-based investors. The Church of England, the Church Investors Group, the Interfaith Center on Corporate Responsibility and other faith-based investors continue to play an important role in ESG advocacy and company engagement, and in submitting shareholder resolutions.
Environmental Megatrends with Social Impact
Climate change and transition risk
Climate change and transition risk
Climate change and the neighbouring effect of transition risk has social implications.
A widespread call is that the transition should be a ‘just’ transition.
In the process of adjusting to an economy that does not adversely affect the climate, sectors that employ millions of workers (such as energy, coal, manufacturing, agriculture and forestry) must restructure. It is feared that the period of economic structural change will result in ordinary workers bearing the costs of the transition, leading to unemployment, poverty and exclusion for the working class.
Water scarcity
Climate change has a negative impact on the availability of fresh water. Some corporations with high water use pose a significant threat to clean and affordable water for communities.
The construction of wastewater treatment plants and reduction of groundwater over-drafting appear to be obvious solutions to the worldwide problem.
However, this is not as simple as it seems:
▶ Wastewater treatment is highly capital intensive, so there is restricted access to this technology in some regions.
▶ The rapid increase in the population of many countries makes this a race that is difficult to win.
▶ There are enormous costs and skillsets involved in maintaining wastewater treatment plants, even if they are
successfully developed.
Mass migration
Mass Migration
The scarcity of fresh water and desertification due to climate change in several emerging countries is believed to be one of the reasons for mass migration streams from developing countries to developed countries where these issues are less present.
Climate change might result in an increase of ‘environmental migrants’ with the most common projection being that the world will have 150 to 200 million climate change migrants by 2050.
Conclusion
As discussed in this section, different social megatrends provide both opportunities and risks for investors and analysts. It is therefore important to be aware of these trends and take them into account when making investment decisions.
KEY SOCIAL ISSUES AND BUSINESS ACTIVITIES
Explain key social concepts from an evidence-based perspective:
human capital: development, employment standards, health and safety,
product liability/consumer protection: safety, quality, health and demographic risks, data privacy and security;
stakeholder opposition/ controversial sourcing;
social opportunities: access to communications, finance, health and nutrition;
social and news media; animal welfare and
microbial resistance.
Where should investors start when they decide to implement social factors in their investment decision?
- A good starting point is to determine which social factors are most controversial or financially material in each industry.
- As a next step, investors can assess **how exposed certain companies are to these sector-specific social factors.
This might depend on their business models or on the nature and geographical location of their business operations.
- Finally, where relevant, investors could assess **critical social factors in their supply chain.
It should be noted that the social elements that are considered to have the largest financial materiality depend on specific aspects mostly related to their field of industry.
The Sustainability Accounting Standards Board (SASB) framework gives guidance on the financial material topics within industries.
Social factors can also be categorised between those impacting
**external stakeholders (such as customers, local communities and governments) and groups of
**internal stakeholder (such as the company’s employees).
See Table 4.1 for examples of social factors that may affect these stakeholders.
SOCIAL FACTORS THAT IMPACT INTERNAL STAKEHOLDERS
Working conditions
Labour standards
Gender balance
Pay ratios
SOCIAL FACTORS IMPACTING EXTERNAL STAKEHOLDERS
Product impacts
Sourcing local content
Tax payments
This section will provide an overview of the key social factors that can be of interest for investors.
It first focuses on the **internal factors, which are:
A. human capital development; B. health and safety; C. human rights; and D. labour rights, including: » freedom of association and employee relations; » forced labour; and » living wage.
Subsequently, the external factors are described, which are:
E. stakeholder opposition and controversial sourcing;
F. product liability and consumer protection;
G. social opportunities; and
H. animal welfare and antimicrobial resistance.
Internal social factors
A. Human capital development
**A company’s long-term strategy should take into account the development of its workforce.
This ensures that the workforce:
is well equipped for completing its tasks;
operates under the latest standards and regulations; and remains motivated.
Good human capital management generates a culture and behaviours where the workforce is positively disposed and productive, rather than taking excessive risks or harming customer relationships.
It enhances social inclusion, active citizenship and personal development, but also increases competitiveness and employability.
