It should have been a vindication for the sustainable investment industry. Shares in fast fashion retailer Boohoo lost a third of their value last month after allegations that workers in its UK supply chain were paid £3.50 an hour. Here was the proof that by avoiding companies exposed to environmental, social and governance risks you could also avoid losing money.
Instead it led to red faces for 20 “sustainable funds” that had put money into Boohoo, including products from Legal and General Investment Management and Man Group. Aberdeen Standard Investments’ employment opportunities fund, which invests in companies with “good employment opportunities and practices”, had Boohoo as its biggest holding as recently as May. It dumped the stock after the allegations.
Covid-19 has focused investors’ minds on labour issues (the S in ESG) more than ever before. So how did so much money earmarked for sustainable investment end up in Boohoo?
Boohoo has alleged there are inaccuracies with the reporting about underpaid workers, terminated its relationship with two suppliers and commissioned an independent review. But there were signs well before the latest allegations that ESG funds should be wary of the retailer. In addition to the deleterious environmental impact of the fast fashion industry, the company’s reliance on sourcing from Leicester was a risk given the city’s well-documented problems with sweatshops. Unlike retailers such as Asos, Boohoo have refused to publish a list of its suppliers and join the Ethical Trading Initiative, which tried to clean up conditions in Leicester. It also declined to recognise the union Usdaw in its Burnley warehouse.
Some fund managers may have been influenced by Boohoo’s reassuring scores from ESG ratings agencies. MSCI, which uses artificial intelligence and alternative data to research companies, gave Boohoo an AA as recently as June, with 8.4 out of 10 for “supply chain labour standards”, well above the industry average of 5.5. Its report mentions Boohoo’s “relatively strong policies and practices” and low reliance on regions where working conditions are poor.
This level of analysis is not granular enough. Rating agencies differ in the factors they assess, the data they choose, the detail they seek and the weights they assign. Tesla, for example, is ranked in the bottom 10 per cent of companies by one ESG rater, and given an A grade by another. Researchers at the Massachusetts Institute of Technology found the correlation among scores from six raters was on average just 0.54.
ASI’s “employment opportunities” fund, to be fair, did its own work, sending questionnaires to companies and compiling a “four-pillar” scoring metric. This ranked Boohoo highly because of factors including strong job creation in deprived areas. ASI told me its methodology only assessed direct employment, rather than workers in supply chains, something it now plans to tweak.
Clinging to pseudo-scientific scoring systems in the face of common sense is one habit the industry needs to change. Fund managers also rely far too much on what companies tell them. It would help if employers were forced to publish audited data on staff turnover, pay distribution between low and high earners, supply chains, health and safety incidents and the use of agency workers.
But here are some other suggestions: read newspapers, especially local ones; look at job adverts for pay and contract terms; check online reviews and employment tribunals for running themes; speak to trade unions. Then get your shoes dirty. Talk to workers and visit suppliers — without management present. When I was invited by Amazon to visit one of its warehouses, I spent days beforehand interviewing workers as they walked home after shift changes. Deep research is time-consuming, but if a newspaper can afford to do it, so can an asset manager.
Crucially, you have to want to know the truth, even if it is that you should dump a stock that is performing well for your fund. ESG evangelists often insist there is no conflict between doing good and doing well. They may be right in the long term, but companies can make a lot of money by compressing labour costs before policymakers and regulators catch on.
Sustainable fund managers should take action as ASI did more often, preferably before scandals break and share prices plunge. It is a sign of progress that so many people want their savings or pensions invested in companies that treat workers well. But without better oversight, the ESG boom risks becoming a waste of their money — and, worse, a wasted opportunity to make the world a better place.