The Social Dilemma
As shown by the Wall Street Journal shedding light onto Facebook’s activities, investors are right to be considering social factors within their investments. However, the lack of easily available data means it is difficult for investors to be easily able to assess this data.
William Bryant, Head of Advisory
In simple terms, an investor’s job is to understand the future value of an asset that they are investing in. The key determinants of that are the opportunities and risks that the asset faces over the period of time that the investor is looking to hold the asset. Increasingly, investors are understanding the importance of taking into account the environmental, social and governance (‘ESG’) factors that may have an impact on an asset’s future value.
Governance has long been seen as a key determinant and something that investors have been focused on when making investment decisions. Environmental factors have come to prominence over recent decades with a growing awareness of the externalities that different business activities produce and whether those practices are going to be sustainable into the future. Social factors, however, are harder for investors to analyse, with less standardisation, limited availability of meaningful metrics and low coverage. In BNP Paribas’ recent ESG Global Survey, 51% of respondents rated social factors as the most challenging aspect to analyse and incorporate in investment analysis versus environmental or governance factors.
The past years have seen a sharp increase in focus on the social aspect of businesses, and the demand for transparency around management of and impact on these issues will continue to put pressure on business leaders to take responsibility.Facebook: What is the Consumer Welfare story?
This week the Wall Street Journal has released a number of investigative pieces into various activities by Facebook. The pieces highlight that Facebook’s platform are “riddled with flaws that cause harm, often in ways only the company fully understands”.
• Facebook Says Its Rules Apply to All, Company Documents Reveal a Secret Elite That’s Exempt
• Facebook Knows Instagram Is Toxic for Many Teen Girls, Company Documents Show
• Facebook Tried to Make Its Platform a Healthier Place, It Got Angrier Instead
The Wall Street Journal has not detailed how many pieces are in the ‘The Facebook Files’ series, so there may be more news to come. In sum so far, Facebook’s management has been aware of serious issues within its products, but has not taken significant action to address these issues. The issues are that its products are related to negative mental health impacts, especially among teens, they promoted divisive discussion and censored users differently.
Facebook is famously the first initial in the ubiquitous acronym FAANG, which has driven strong performance for many fund managers, particularly in the hedge fund space. While it is hard to dis-aggregate an individual news story from wider impact on a company’s share price, following the publication of the Wall Street Journal’s third article Facebook’s stock sold off by -2.2% versus the Nasdaq Composite being -0.3% at the same time, representing a $20bn loss versus the market.
The below shows the share price performance of Facebook and the Nasdaq on Wednesday 15th September.
Source: Google Finance
Was the market reacting to the Wall Street Journal investigation and the potential future impact on Facebook’s business model, or were there other factors? Will there be repercussions for Facebook’s business model either from their consumers, from their customers (advertisers account for 97% of revenue), or from legislators? Only time will tell what the impact will be, but as an investor this is a risk that you are taking on.Understanding that risk is difficult as data can be hard to come by and may not be standardised, technology changes rapidly, and assessing the social impact that a product may have is a complex undertaking. So investors increasingly rely on ESG ratings providers in order to support their investment due diligence process. As we have highlighted previously in our ESG Data Whitepaper, understanding the methodologies and assumptions is key. In a recent research piece by newly launched activist firm Engine No. 1, the correlation between ESG data providers was shown to be low and particularly disparate for social factors. Below shows the dispersion of ratings among four of the larger ESG ratings providers as shown in Engine No. 1’s research piece.
Source: Engine No.1- Total Value Framework
Refinitiv scores Facebook in the top quartile of peer companies, although the company scores badly for product responsibility, whereas Sustainalytics scores Facebook in the bottom quartile. The social side of a business is much more complex, and therefore requires an in-depth understanding of how the products and services that the firm provides and its operations actually might have an impact on its various stakeholders, and ultimately on financial performance.Where Next?
While assessing social factors can be difficult for investors, these are important pieces of information that do have an impact on an assets short term price, and depending on the reaction of stakeholders may have a longer term impact. It is an investor’s job to be cognisant of the risks that they are taking on and balancing those with the perceived opportunities. As environmental issues have been recognised, by most, as a significant risk factor, so social factors will be too, and an ESG integration framework should try to assess these factors as systematically as possible. Identifying what ‘S’ factors are going to be financially material to a specific company at any point in time is a key element of modern investment research.Get in touch at info@northpeakadvisory.com if you would like discuss how you can spark lasting change within your firm.