The ESG factor: how can investment managers effectively source and integrate these metrics

Investors are under growing pressure to factor Environment, Social and Governance (ESG) into their investment decisions, requiring a broad and complex set of metrics. As ESG reporting continues to evolve, what can investment managers do to respond?

What is ESG and why is it growing in prominence?

Increasingly three central factors that make up the sustainability and ethical impact of an investment: Environment, Social and Governance (ESG), are becoming key criteria in investment decision-making and reporting. Obviously, investments are made on the basis of financial return, but the ESG factor adds another dimension when decisions are being made around investment.

ESG can also be considered to an extent that it applies to entire economies, not just businesses. One of the most prominent historical examples was the reluctance of many countries to invest in South African enterprises while the apartheid regime was in effect.

Public opinion plays an important role in ESG. More recently, the increasing number of mass shootings in the US has resulted in the ESG factor impacting on businesses that develop, manufacture and produce munitions, as potential investors raise ethical concerns.

Another major ESG factor is that of climate change. Investment Magazine reports that in 2018, a record number of businesses received shareholder resolutions seeking increased disclosure. Most of these concerned climate change, but overall, it’s clear that there’s a growing demand for ESG information, and that it’s having an increasing impact on investment decisions.

ESG is becoming known as ‘ethical investing’, and the market for it is growing. From a generational perspective, a recent NZ Herald article suggests that millennials and retired baby boomers are behind New Zealand’s fast-growing embrace of ethical investing – both ends of the age spectrum. Funds in sustainable investment in New Zealand increased 40 per cent over the previous 12 months.

One of New Zealand’s biggest investment product categories is KiwiSaver. KPMG research indicates that KiwiSaver providers are falling down when it comes to disclosure over their ethical investments. Most claim to have a responsible investment approach, but their use of “ambiguous and inconsistent terminology” is not satisfying their investors.

Ian Silk, Head of Australian Super, recently underlined the importance of ESG when suggesting that super funds considering ESG risk were in fact acting in the best interests of their members. “Failure to properly manage ESG risks can lead to reputational damage, regulatory scrutiny, civil and criminal litigation, profit downgrades and ultimately poor investment results. Clearly, then, taking steps to improve companies’ ESG performance is in members’ best-interests duty,” he is quoted saying in Investment Magazine.

The transparency challenge for investment managers

So what kind of impact is ESG having on investment managers? Led by investors themselves, there’s a growing demand to better understand how their investments align with ESG principles. This is not just to achieve a better ESG rating, it’s also driven by a desire to be able to disclose to their clients how their money is being invested.

The challenge that investment managers face is one of transparency; it’s not always easy to drill down into a fund and see exactly where the investments are. This is because many funds have links to an index; an example of this is a fund that’s linked to the ASX200 (Australian Stock Exchange). Drilling down into the levels of the ASX200 is known as ‘look-through’ – learning exactly what investments are held within the ASX200.

What it comes down to is that it’s often a complex task to discover exactly what funds are being invested in. If obtaining full disclosure is difficult, then there’s a greater challenge in finding out the investment’s ESG rating.

Relationships between companies are another challenge. Take an investment manager whose ESG principles include not investing in any businesses that manufacture firearms. They decide to invest in a finance company, but what they may not know is that company lends money to firearms manufacturers. Or a supply chain may be sourcing their materials or components from providers with poor ESG records. In both examples, they have inadvertently compromised their ESG integrity.

Those are very basic examples; often there’s a whole web of connections that need to be untangled. Understanding the relationship between companies is therefore a necessary, but often complex, challenge when it comes to ESG investments.

A powerful solution: leveraging Refinitiv ESG data

Recently, we announced a working relationship with data provider Refinitiv. ESG data is a part of their offering, covering nearly 70% of global market cap and over 400 metrics. It’s designed to help investment managers make sound, sustainable investment decisions, and it also helps them to spot trends and make comparisons, which then informs their decisions.

Refinitiv provide ESG ratings for potential investment opportunities, so investment managers can make decisions that are at least in part predicated on that rating. Refinitiv considers literally thousands of factors within the ESG spectrum when they generate a rating. For example, their ESG rating of Air New Zealand takes into account the amount of renewable fuel they use. The same method would apply to another airline like Qantas. If investment managers are comparing both airlines when making a decision about which one to invest in, their ESG ratings by Refinitiv could play a big part in making that decision.

AlphaCert is working with Refinitiv to integrate their ESG data with the rich set of investment data managed through our platform. The goal is to provide an integrated solution that provides ESG data specifically for investment managers. The idea is to display ESG ratings in a simpler context, which will make it much easier for investment managers to differentiate between funds based on their ESG rating.

As the demand for ethical investing grows, the ESG analysis and reporting will become increasingly important. Our role is to bring data and solutions to investment managers fingertips and help our customers gain even greater control over their investments.

If you’d like to find out more about AlphaCert and Refinitiv’s ESG data management capability, schedule a demo today.

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