On November 4, Terri Morgan, SVP & Sales Manager at RIMES, was joined by Noel Friedman, Executive Director & Business Manager for ESG Research Products at MSCI, for a virtual ‘fireside chat’ on the topic of ESG investing. What follows is a summary of the main themes discussed during the event.
The ESG market today
Investing based on Environmental, Social and Governance (ESG) factors may seem like an emerging trend, but in fact it has been building momentum for around 20 years. A wave of interest has been sparked by the founding of the Principles for Responsible Investment, and with that momentum from large institutional investors.
As the market has expanded over the past couple of decades, so too has its focus. In the past, ESG investing was mostly about aligning investments with values by, for example, screening out companies with problematic activities.
Today however, ESG investing is often focused on using ESG factors to help enhance long-term returns. There’s a broad recognition that firms with good ESG scores will be better placed to overcome specific risks in the future and therefore represent good investment opportunities. ESG investing is increasingly seen by firms as an element of fiduciary responsibility.
Sourcing ESG data remains a challenge
Although the ESG market is maturing fast, there’s still a long way to go from a data perspective. Only a small percentage of companies today disclose even the most basic ESG data, and companies like MSCI are therefore required to source the information they need to produce ratings by mining alternative datasets.
There’s a misperception that because little is being disclosed directly from companies that ESG data is of poor quality. In fact, alternative data provides for a broad range of insights that reveal the ESG risks businesses face and how effective they are in managing these risks. In fact, even when disclosure of ESG data is standardized and improves, alternative data will still form the bedrock of ratings analysis as it provides an independent view of companies’ activities.
Understanding ESG ratings
Demand for ESG products stems from a broad range of investor goals. These include investing in firms that are active in sustainable industries, those with strong ethical values or those that are looking to manage ESG risk long-term, for example. Most investors are, however, looking to integrate ESG as a means of enhancing financial returns.
The ratings used to score investment prospects must be based on a rigorously methodological approach to avoid basing scores on subjective analysis. It’s important that ESG scores are based on consistent methods and close consultation with the market.
Some of the regulations coming down the pipeline will be a challenge as firms will need to be able to provide specific ESG data to clients and regulators that some may struggle to source. Firms can rely on partners like MSCI and RIMES for some of this work as they are out there sourcing much of this data, doing so will help them meet the regulatory burden while also freeing them to focus on their core activities.
Other points raised during the discussion include:
- The US Department of Labor’s October 20 rule stipulates that Employee Retirement Income Security Act fiduciaries cannot invest in “non-pecuniary” vehicles. The consensus was that this is in keeping with the investment goals of most ESG funds, which use the rating to identify low risk investments that may deliver better long-term returns.
- COVID-19 is forcing ESG investors to change how they think about companies. In particular, employee safety was once primarily a factor when investing in firms in heavy industry or where the likelihood of accidents is above average. Now it’s about ensuring people can work in a COVID-secure way, and includes most industries. COVID has also highlighted the ability of companies to adapt quickly to change as a key consideration in long-term investments.
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