As more data on environmental, social and governance (ESG) factors becomes available and widely adopted, so does the debate grow about the efficiency and materiality of this information, and how best to use it while investing.
Pulse Online caught up with Shila Wattamwar, Executive Director, Strategic Partnerships, at Sustainalytics, to ask her what the present and future of ESG data look like.
Sustainalytics is a global leader in ESG and corporate governance data and research. They provide leading sustainable information, scoring and contextualized analysis used in the composition of key ESG indices such as the EURO STOXX 50® ESG Index and STOXX® Europe 600 ESG-X Index.
Shila, ESG has certainly become a core concern for investors in recent years, and a central criterion in many portfolios. How has ESG data evolved during this time?
I joined Sustainalytics more than four years ago and prior to that I was in the index industry for about 10 years. Certainly, I’ve seen ESG data evolve in that time.
A lot of that evolution has revolved around the intersection of increasing investment use cases, as well as corporates taking the topic more seriously and understanding that it’s important to disclose their ESG parameters. This seems to be especially true of large and developed markets.
There are quite a few different market forces that have encouraged this. We’ve seen the advent of many ESG indexes, and companies are thinking about their inclusion into them. The availability of public ratings has also seemed to catch the attention of many of these large-cap, developed-market companies. A vast majority of companies in the S&P 500 Index now issue corporate, social and responsibility (CSR) reports, whereas four or five years ago possibly less than half of them did.
The other driver is exchanges. Various stock exchanges around the world are working more closely with companies around ESG disclosures. They want to encourage companies within their domicile to be thinking about environmental, social and governance issues such that it does provide that much more sustainability for companies listed under the exchange. In certain places, it’s a means for an exchange to offer an additional service to companies.
Finally, we’re seeing various taxonomies arise that are encouraging investors to demand disclosure. The more investors do, the more it impacts companies.
Another big part of this evolution is that now we are no longer just working with the asset manager. We are also working with other very key players and intermediaries that make ESG data a basic and integral component of the investment landscape. Four years ago, and even before, ESG data was predominantly used for portfolio construction and qualitative analysis or screening. But now we’re seeing it being used across various functions of the investment world. While before our audience would typically be managers working for asset owners, we now find that our research is feeding into a larger flow in the investment landscape, including the wealth and retail side, and intermediaries such as index providers, custodians and investment consultants.
A common criticism with the advent of a larger pool of ESG data is the lack of consistency among providers.
That is certainly a question we hear amongst the market and our clients. But it’s important to note that that lack of consistency is also parallel to the lack of understanding by the investor. It’s really important to understand what a specific ratings framework is attempting to measure. We do all really look at different scopes. It is important to understand exactly what the underlying inputs in an ESG framework are, and what a framework is meant to measure. And once an investor looks under the hood and understands that, it will help reconcile why many of the differences occur.
With respect to that, different measures could be additive to each other. We do have multiple clients that look at two different ESG frameworks, not because they measure the same thing but because they measure different things. And they can be additive. Even within Sustainalytics we have about 8 to 10 research products that are looking at different angles of sustainability.
That seems to be a key point, as different ESG approaches will obviously result in very different portfolios.
There are different data sets that one can be faced with, whether that be within one provider or across different providers. I think that’s a result of this idea of sustainable investing evolving. I look at it as a good thing. Investors need to think about what it is that they’re trying to capture and what their motivation is. Are they looking to create portfolios with better risk-adjusted returns? Or are they looking to align their portfolios with their values, underweighting or divesting from certain companies? Or are they looking to create a really opportunistic portfolio that captures a particular theme? And these are not necessarily mutually exclusive objectives. However, each of these approaches will result in very different portfolios.
We’re hearing more interest about the topic of impact investing. How does ESG data capture that?
Impact investing is indeed getting more attention and it pertains to the more thematic portfolios. It’s a very exciting area and very much in line with how investor and consumer preferences are changing. I think there’s still a lot of room and opportunity for it to grow as it relates to reporting. Until we get to that point where we have that strong impact reporting mechanism, we may still see a smaller allocation to impact portfolios. This despite the fact that there are some really interesting impact thematic portfolios out there around the topics of gender and climate change.
Finally, where do you see ESG data in the next few years? What are the big changes that may take place in this sector?
I think that ESG risk management will become inherent to the general risk management process. There are material issues that a company really does face and that investors are increasingly realizing that they shouldn’t ignore. In the near future, I think ESG risk management will become integral to what an investor considers when thinking about the valuation of a company.
I also think that in the next ten to 20 years, parts of ESG, especially the more impact and thematic investing side, will become very linked to changing consumer preferences. Right now, when you look at best-in-class portfolios you are looking at those companies that are doing the best that they can from an ESG standpoint, within their line of business. But I do think that eventually it will no longer be about looking at the best initiative. Instead, because of evolving consumer preferences, companies will have to think about their impact to society as this can become material to their success. So, although an energy company will remain an energy company, it will hopefully start seeing the material benefits and virtues of being more and more invested in renewable or alternate energy sources. The automotive industry will start thinking about changing their product mix, and so forth.
