Insight 6 October 2020

ESG data, apples, pears and ESG alpha

When the conversations around environmental, social and governance (ESG) considerations as part of investment decision making started in the early 2000s, these issues were broad, intangible and subjective. The problem with intangible and subjective topics is that it is difficult to measure and report.

Why we need to measure and report

In the words of the mathematician Karl Pearson; “That which is measured improves. That which is measured and reported improves exponentially.” This means that if we were to see any improvement in ESG metrics, we must not just measure but also report ESG metrics.

The first sustainability reporting framework was developed in 1997 by the Global Reporting Initiative (GRI) and followed since by the CDP, CDSB, IIRC, SASB and TCFD. All with the goal to assist companies to accurately disclose their ESG metrics. Yet, many investors still state ‘greenwashing’ as a problem or even deterrent, due to the lack of quality data and consistent reporting. Some even refer to measuring the entire fruit basket from apples to pears.

It was with great elation that five global organisations — CDP, CDSB, GRI, IIRC and SASB — recently announced a shared vision for a comprehensive corporate reporting system and their commitment to collaborate to achieve this vision.

This does not necessarily mean that all financial statements should look the same, or that all ESG ratings should give the same answer. It does however mean that investors should be able to rely on data in annual reports and ESG reports to base their investment analysis on, and unlock ESG alpha.”

Karlien De Bruin Director, Product Development - ESG

When two investors conduct fundamental analysis on the same company in order to calculate fair value, they may attain different results. We should therefore expect the same when rating ESG factors. The ESG ratings provided by several providers are essentially results after data was analysed with their specific methodologies. It should therefore be expected that the same company might achieve different ESG ratings from different ESG rating providers.

When investors use ESG ratings from different rating providers that provide very different results, they can use that as an additional tool to unlock hidden ESG information and alpha when they understand why the information differs. Instead of trying to “fix” ESG ratings and rankings by standardising the measures, why not use it as further data points in the analysis?

Investors only know whether their investment is doing well when compared to its history or compared to other benchmarks. Here we once again enter a murky world where not all benchmarks are comparable and not all “peers” are indeed “peers”. For instance, when comparing the top 5 ESG ETFs they tend to be tilted towards the technology and finance sectors, which raises the questions:

  • Was this the intent? Or just an accidental result due to the metrics used?
  • Are these technology and finance companies in the indices good quality ESG companies or was it a default due to their industry?

A detailed understanding of the construction of various indices and benchmarks are needed to know which benchmark makes sense for your investment. The new EU Taxonomy, Disclosure Regulations and Low Carbon Benchmark Regulations attempts to improve transparency and provide a common language to allow investors to clearly identify comparable benchmarks and peers.

Through the commitment from reporting frameworks to collaborate, the drive from ESG data providers to improve and expand their databases and the less subtle push from ESG regulations, the ESG landscape is maturing and making it simpler to compare apples with apples.

Let’s talk…

Contact Sanne if you require our expert team to advise on various ESG ratings, benchmarks, metrics and reporting services available. We would be delighted to speak with you to discuss how Sanne can assist. For more information please contact Karlien De Bruin directly.

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