Saving the World (While Generating Returns) with ESG Data [2 of 3]

• Sustainability-oriented investing and reporting provides an important opportunity for digitization and enhanced performance
• ESG-related investing is already driving trillions of dollars of investment decisions – making ESG-investing one of the few growth areas in the investment world
• Evidence suggests that investing with ESG filters has a neutral to accretive effect on financial performance; since ESG attract capital, why not give it a shot
• The set of ESG data providers is scattered and waiting for the inevitable consolidation may be too late; investors willing to capitalize must take action now
• The unknown unknown: buying data is easy, but making sense of it in the context of your portfolio ain’t so; brace yourself for a lot of data engineering, or call Novus

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View Part 1 of this series, 3 Reasons Why Your Firm Might Be Making Bad IT Decisions

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In my previous post on data infrastructure, I discussed why institutional investors, be they allocators (a.k.a. asset owners) or managers – people who are highly compensated to make good investment decisions – tend to make bad technology decisions. Let’s be a little cheerier this time and talk about the environmental, social and governance opportunity in asset management.

Remember that children’s cartoon Captain Planet? Through the 1990s, this superhero vanquished such enemies as Dr. Blight, Looten Plunder, Sly Sludge, Hoggish Greedly and Verminous Skumm.

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So what’s he doing now? I think he’s running a quant fund. Here’s why.

Doing no harm does no harm

The kids who grew up on Captain Planet are now making investment decisions, so there’s a genuine interest on the buy side to focus on ESG issues as well as near-term financial results. When these concerns were first laid out in the corridors of Wall Street, the rear-guard position was, “You can be rainbow warriors or you can be investors, but you can’t be both.”

They were wrong. New York University looked at 245 studies published between 2015 and 2020 and found that 43% of them found that investments that screened for climate impact outperformed the market and a similar number were either neutral or mixed. So, at the very least, going green probably doesn’t cost you anything, so why not go green? If you don’t care about performance, at least care about AUM; ESG investing, along passive investing, is among the few growth areas in asset management today. That question about whether to go green or not is rhetorical and became even more so when the Financial Times reported that the majority of ESG funds have outperformed the broader market over the course of a decade.

The insight was that companies which pursue ESG objectives tend to be the same ones dedicated to reducing costs and improve productivity while uncovering new revenue channels. In short, they’re not complacent.

Another compelling reason to consider ESG in the investing process, though, is risk mitigation. Risks related to gender inequality or inadequate sanitation or weak justice institutions are often unquantified, but that’s because they haven’t come to the attention of credit rating agencies yet. No doubt they will, and ESG investors will be a step ahead.

For all these reasons and more, $17.1 trillion – one third of all professionally managed funds at the end of 2019 – was managed according to sustainable investing strategies, an industry group reports. And the momentum is, to use a word judiciously, sustainable; one out of every five dollars of inflows today are targeted toward funds focused on sustainability, according to the NYU team.

It helps that some of the biggest players in the game have fully embraced ESG. BlackRock, the world’s largest asset manager, is all in. Chairman Larry Fink’s 2021 letter to CEOs is peppered with ESG references, and his enthusiasm is spreading throughout the industry. It’s also feeding back into federal policymaking. BlackRock’s former sustainable investing head, Brian Deese, is now director of President Biden’s National Economic Council.

Big problems, bigger data

I won’t say you can’t solve problems with money, but a lot of money can get wasted in the process if portfolio analytics is not your domain of competence. Let’s look at the first order of complexity: choosing the right provider.  

As an investor, you can choose among at least 150 ESG data providers covering around 150,000 companies. It gets messy here, because only 17 providers cover more than 450 companies. There’s bound to be some consolidation in the future but, at this moment, this is a nascent industry niche with a surplus of vendors.

One driver for consolidation is likely to be standards. Right now, there are none. There are, however, more than 30 security masters – distinct, independent ways to identify companies to be rated. As a result (drum roll: here is the unknown unknown), some asset managers are paying more to integrate the data than to license it!

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Integrating ESG data is not for the faint of heart. While not complex in principle, it will consume your time in ways you had not imagined before. Let me offer you a couple examples:

• You bought an ESG score from provider XYZ, which uses a proprietary taxonomy of company identifiers which has nothing to do with ISINs, SEDOLs, CUSIPs, Bloomberg Ticker or any commercial identifiers (e.g., the gvkey of the Compustat database) which you are using to identify positions in your portfolio. Now what? Well, you need to maintain a system of cross-mapping between XYZ and your own way of identifying securities. And mind you, XYZ will release a change which you’ll need to be on top of every two weeks.  
• You bought environmental ratings from provider ABC on a 1-10 scale as well as social ratings from XYZ in the form of A-E letter-ratings. The former is cross-industry while the second is industry-specific; that is, there is forced quintiling of companies in each industry group and association with a letter. For you, as the investor, it’s important to balance the scorecard at a 75% environmental weighting and a 25% social weighting. How do you harmonize it all? And how do you aggregate across the portfolio?

As usual, if you chose the do-it-your-own route, you’ll be spending 95% of the time preparing the data and 5% using them for the intended purpose. Unless, that is, you use Novus, which offers industrial mechanisms to tackle all of the above.

Room for improvement

The whole point of Big Data is to be scalable but, in the ESG realm, it isn’t that yet. The data is out there, and present compelling opportunity for action, but it’s scattered among many providers; further, buyers lack the infrastructure to integrate ESG data in the context of their portfolio, which is a crucial step to reap the ROI of the investment. This is a roadblock on the road to a sustainable investment world, one which Novus can help you unlock.

If you're interested in more on the topic, here's our Guide To ESG Data, our research dashboard where you can examine ESG investing trends among hedge funds, and a webinar on the same topic.

Next time, I will present how skill-set analytics present another compelling opportunity for institutional investors.

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View Part 3 of this series, Assembling the "Investment Avengers" Using Skill-Set Analytics

View Part 4 of this series, Are We Leaving $800 Billion on the Table?