The slavery scandal engulfing fast fashion brand Boohoo has highlighted the challenge asset managers face when trying to pick stocks for an ESG portfolio, especially when it comes to the social pillar that gained prominence in the wake of the Covid-19 pandemic

Since the pandemic hit, numerous pieces of research have indicated that the ‘S’ in ESG has become more important for investors and greater attention is now being paid to how companies treat their workers.

Boohoo is one of the most prominent examples of how this greater focus can lead to a fall from grace. The fast fashion brand came under fire earlier this month following an undercover investigation from The Times, which revealed workers at one Leicester factory were being paid as little as £3.50 an hour, less than half the minimum wage for workers over 25 years.

See also: – The funds exposed to Boohoo slavery investigation

Several days earlier, a separate report raised concerns Leicester factory conditions were putting workers in the Boohoo supply chain at risk of Covid-19 infection.

This led to Boohoo being placed under investigation by the National Crime Agency for modern slavery under orders from the Home Office, while its share price took a tumble and remains 43% below its recent highs and some 23% down year-to-date, despite the allegation remaining as yet unproven.

Lee Wild, head of equity strategy, interactive investor, said: “The allegations are serious and there is real risk of long-lasting reputational damage, which could have a telling impact on the company’s bottom line if proved correct.”

Tough choices

According to Eleanor Price, fixed income investment analyst at Kames Capital, the sandal shines a spotlight “onto the importance of responsible investing AND the resulting fallout if companies are found deficient on the ESG front”.

However, she notes this also highlights the difficulty of gathering the information necessary to construct an ESG portfolio that avoids such investments, given that many asset managers rely on third-party research to help with portfolio construction.

“A quick perusal today of two of the main ESG rating providers shows that in the case of Boohoo, one rates the company highly whilst another ascribes a medium risk assessment,” Price said.

“This poses a challenge to effective ESG investing especially the ‘Social’ element.”

In fact, a number of ethical funds had invested in Boohoo prior to the scandal, unaware of the issues it faced. Among these was Lesley Duncan’s ASI UK Impact Employment Opportunities fund, where Boohoo was the largest holding at 3.4%, and Premier Ethical with a 3% holding. 

As the slavery allegations came to light, ASI announced it was divesting from Boohoo across its portfolios, while Premier also removed the stock from its Ethical fund. However, the question remains of how such controversies can be avoided by ESG investors in the future.

Flawed ratings

Price warned one important takeaway from this is that fund managers should not rely solely on ratings agencies to assess the ESG credentials of securities.

She said: “As themes of ESG and responsible investment become ever more popular, scrutiny from all angles will increase and this is where the glimmer of hope lies; the rating agencies are paying ever more attention to ESG issues and we anticipate that ESG gradually becomes part of the annual audit process in many jurisdictions.

“However, the more sceptical have commented that as both accountants and rating agencies are paid by the institutions they are assessing, the final assessments might not be as independent and impartial as required.”

She added this highlights “the advantages of being an active and often sceptical independent investor” when trying to avoid such scandals and therefore protect the portfolio from the falls in stock price.

“In a corporate world with global supply chains resulting in a proliferation of subcontracting and foreign jurisdictions, there will always be Boohoo scandals to be uncovered, and not just in the retail sector,” she said. 

“However, the market response to these issues and the public demand for ever more scrutiny means that corporations worldwide should be paying more attention to these issues in order to continue raising ESG standards across the board.”