On April 4, RIMES hosted its inaugural ESG Forum. In a panel debate moderated by Willemijn Slingenberg-Verdegaal, Co-Head Climate & ESG Solutions at Ortec Finance, Tom Beagent, Director of Sustainability at PwC; Ashley Claxton, Head of Responsible Investment at Royal London Asset Management; and Karin Malmberg, Associate Director of Client Relations at Sustainalytics discussed key trends around the ESG market. What follows is a summary of the key points raised during the debate.
How investors can best integrate ESG criteria into decision-making
The way that investors should integrate Environmental, Social and Governance data will depend on whether their objectives are impact-driven (i.e. they want to invest in a portfolio of businesses that are having a positive effect on the environment and society) or returns-driven (i.e. they are concerned about the ability of ESG criteria to drive better returns). Or in many cases both.
There are different approaches for each investment objective, such as comparing the ESG performance of a portfolio against that of a financial benchmark (returns-driven) or looking to track ESG performance over time (impact-driven), for example. Whatever the business driver, the panel agreed one thing is certain: moving forward, much more data will be required for effective portfolio and risk analysis.
The panel discussed some of the other elements that will shape how investors integrate ESG data into decision-making. The asset class will be a determinant, and so too will the fund type. Passive funds in particular will be more difficult to manage, as firms are required to ensure there isn’t too much variance in the tracking margin – something which ESG data may make more of a challenge.
Another key factor that will influence how firms use ESG data is whether they are dealing with equities or fixed-income products. As the panel set out, all ESG data and analysis currently comes from an equities perspective. When it comes to fixed-income assets, the data simply isn’t there. So, for example, a company with an ESG rating will have the same rating applied to all of its bonds, even where the bonds have very different ESG credentials and risk profiles. For this reason, there’s a need in firms for strong data expertise to dissect ESG data.
As the panel discussed, ESG is a complicated area and inconsistencies are common. The challenge is to work with complexity and find people with the skills needed to turn inconsistency into the foundation for good decision-making.
Standardization in ESG criteria
Due to the complexity of ESG data, the panel had mixed views about the usefulness of efforts to try and standardize the area. Efforts to create a taxonomy for ESG data management are useful, but there’s always the danger that as soon as the taxonomy is ready, the market will have moved on. Some panellists also expressed concern that trying to standardize and bring consistency to ESG may stifle innovation in this still-nascent area.
One of the ways suggested to get around this challenge is to have a basic level of standardization to produce an ESG score for companies – but only to use this as a starting point for more in-depth research. Due to the complexity of the field, investors should be given access to all underlying data so they can see for themselves the nuances and inconsistencies that go into ESG benchmarks first-hand. This will provide a more accurate view and allow for better-informed decisions aligned to individual strategies.
Sourcing ESG data
The ESG data market is already large, and it’s growing constantly. Not only must firms choose the right data partners to work with, they must then find ways to get the data into the business, standardize it, map the data from issuers down to the security level, and then get all relevant data to fund managers. Coverage is also a key consideration. One panellist noted that they were only seeing around 40% coverage of their portfolio with ESG data providers – something that’s of increasing concern as clients ask for more and more of this information.
While the situation is currently far from perfect, there are some benefits to be found in the gaps around ESG data reported by businesses. For active managers, these gaps can be used to generate alpha, helping them differentiate. Green bonds are a good example of this: by looking for bonds that are not labelled ‘green’ but actually meet many green criteria, active managers can often find companies that deliver better returns compared to those offering bonds branded as ‘green’.
When will ESG hit the mainstream?
The panel agreed that due to consumer demand, and the fact that companies with high ESG scores also seem to deliver high returns, it’s inevitable that ESG will likely become mainstream – to the extent that it won’t need to be discussed as a separate investment topic. Companies that start pivoting towards ESG products now will therefore be better placed to exploit opportunities in the future and react to any changes in regulation.
Things are changing fast. Firms are being asked more and more questions by their clients about how green and ethical their investments are – and this is only set to continue.
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