The rapid growth in environmental, social and governance (ESG) investment strategies has been underpinned by the thriving availability of corporate sustainability metrics. Investors have taken up this information to integrate it into financial analyses and decisions.
While the quality of ESG data is improving by the day, questions remain about reliability, consistency and utility. The topic featured prominently during STOXX’s Innovate2Invest conference last month. Below are key excerpts from participants during a panel on sustainable strategies at the conference. Watch the entire debate here.
EJ Shin, Portfolio Manager at the Client Portfolio Solutions (CPS) team at BlackRock: “ESG is going mainstream; it is no longer a niche market. Besides regulatory momentum and increasing client demand, from an investment perspective there is an increasing awareness and evidence around ESG factors as a source of alpha over the long term and also as something that can help us mitigate risk. For many years, investors saw ESG as a risk trade-off. For instance, the first question that people ask is, ‘what is the loss I have to stomach?’ And our thinking is that, today, probably none. Probably you will get more yield over the long term. Thanks to more granular data that is available, as controversial as they might be, and also technology that allow us to run more enhanced analysis, we don’t need to worry about those losses anymore.”
David Barron, Head of Index Equity and Smart Beta at Legal General Investment Management: “We did a quick analysis on US companies looking at some of the major providers of ESG scores and found that the correlation among the final ESG scores across the providers is about 30% or 40%, depending on the period you are looking at. That’s pretty low. And that could lead to some different portfolio results. Our view is: you should align your belief system with how that ESG score is constructed. How do you construct a portfolio that takes into consideration the potential for some data fallacies? Even if you look at the raw metrics, there are also some fairly low correlations between them. It’s more of an education that is required on the end user: beware of the unintended consequences that could result if you are not paying attention to the specific construction in these products.”
Ian Webster, Managing Director, Indexing Business at Axioma UK: “The vast majority of this data is self-reported. How much of the data is being audited? Setting some standards, like accounting standards, would give investors at least some view that company A and company B, when they are reporting a specific number, are talking about the same thing. I don’t think many people have much confidence in the data at this stage. My suspicion is that in a hundred years’ time we may still be arguing about what we mean by ESG. Transparency on what the data actually is is vitally important. However, we are going to have to live with inconsistencies for the foreseeable future and we are still going to keep the seven, eight or ten vendors for some considerable time, but you’ve got to get to that transparency.”
Pawel Janus, Head of Passive & ETF Research and Investment Analytics at UBS: “Where we do see growing interest and demand from investors is in the need for transparent reporting around sustainable metrics. One of the key constants we hear is the consistency across ESG raters. I wonder whether we’ll have the convergence of ratings like we had in the credit space when credit ratings started to be introduced on a broader scale in the 1960s. You need heterogeneity of methodologies; you need heterogeneity of assessments and in the end, it is investors who can decide what is more compelling and convincing for their ESG-related objectives. Also, you are going to have increasing demand on real-time reporting around ESG issues. This is because investors, as well as asset owners, want to understand in real time what their ESG-related risks are in their portfolios.”
Willem Keogh, Head of ESG, Thematic and Factor Solutions at STOXX: “We have granular data available. We have more sophisticated investors who are looking for what we at STOXX call integrated solutions. We are moving away from the ESG score; and it is very interesting that not only the index providers, but the data providers and all our clients are understanding the data much better. They understand what can be captured. If we use sophisticated software, we can now really start to do proper empirical research: are we really capturing what we are saying we are capturing? The concepts that we are seeing at the moment are significantly superior to what was around three or four or five years ago.”