In recent years, individual and institutional investors’ interest in more socially conscious investment strategies has exploded. At the end of 2020, more than $35 trillion was invested worldwide in funds that consider environmental, social, and governance (ESG) factors in addition to traditional financial analysis. By one estimate, ESG investments will soon account for a third of all global assets under management.

But the “S,” or social, dimension of these funds has so far been limited and illdefined. This is at least partly attributable to the vast and varied effects companies have on society. Researchers, civil society advocates, and investors rarely agree about what constitutes “good” social performance. And there is often insufficient data on companies’ social effects, which inhibits asset owners and managers from understanding how these issues relate to a company’s or portfolio’s financial performance.

To compensate, most “S” metrics assess internal company processes and policies, rather than their core business practices and actual impact on society. This analysis fails to provide a meaningful assessment of corporate actions and risks. Because of these challenges, and the urgent risks posed by global warming, most ESG funds focus overwhelmingly on the “E.” According to one recent study, 68% of U.S. and European assets invested using ESG analysis were in funds that target climate change and other environmental issues.

But the Covid-19 pandemic has drawn increased attention to social concerns, particularly growing income inequality and the plight of low-wage workers who provide many of the goods and services we rely on. In the ESG context, this attention has focused primarily on reining in CEO pay and improving the diversity, health, and well-being of companies’ direct employees. These are promising developments, but they pay insufficient attention to the way that outsourcing, both domestically and globally, has fundamentally reshaped the workforces on which most modern companies rely...

...The growing demand for ESG investing presents an opportunity for asset man - agers to encourage companies to strike a better balance between near-term cost savings and the creation of decent, safe jobs around the world. But this will require addressing the challenges that to date have limited the quantity and quality of “S” analysis. Fund managers and ESG data providers must get more creative in assessing social performance and look more directly at the ways company earnings may depend on illegal labor practices, inadequate and inconsistent pay, chronic overtime, and unsafe working conditions. Over time, this will require obtaining more and better information regarding a company’s labor costs, including those associated with outsourced workers. Finally, while improving the treatment of workers is likely to yield a host of long-term benefits, both to companies and society, realizing these benefits will not be free. Unlike many environ - mental and governance improvements, raising the quality of low-wage work is likely to entail persistent costs. Investors who want a genuine “S” in their ESG funds will need to be prepared to pay for it in the form of more modest returns. Fixing the “S” will require the partici - pation of asset owners and managers, investment consultants, ESG data providers, and governments...