ESG Data, ESG Scores

Rising Importance of ESG Data

ESG data is a booming market, projected to hit $1 billion by 2021, according to a study conducted by Opimas. ESG investing was first introduced in early 2004 when former UN Secretary General Kofi Annan wrote to 50+ CEOs of major financial institutions, inviting them to participate in an initiative to find ways to incorporate ESG into the capital markets. A year after this initiative, a report entitled  “Who Cares Wins,” by Ivo Knoepfel was published emphasizing that the environmental, social and governance factors in capital markets equals good business sense and sustainable markets. Sixteen years later, everyone is still trying to invest more responsibly.

ESG data shows how corporations respond to climate change, how they treat their employees, benefits that their management/board of directors receive, how they manage their supply chains, and generally how they built trust with the consumer base. There are many drivers for the increased interest in ESG investing like expanding regulations, the data being available to investors as a result of improving company disclosures, etc. This type of data also allows investment firms to incorporate non-financial, non-traditional type of data into their analysis. For example, asset managers are using ESG data for portfolio selection, voting practices, risk management, etc. The report, ESG Data Market: No Stopping Its Rise Now highlights the following:

  • ESG market hit $617 million in 2019 and is expected to grow annually by 20% along with 35% growth for ESG indices
  • ESG spending is concentrated in Europe (~60%) but is expected to gain greater traction in the US and Asia. In Europe, the growth has been supported by the regulators
  • Asset managers in Europe will be required to integrate ESG considerations into their fiduciary duties by 2021. Many companies in the US have already included this initiative in their corporate filings
  • Financial services companies are the biggest buyers of ESG data. This group includes: buy-side, sell-side brokers, consulting firms and investment advisors, as well as some corporates
  • ESG market is divided into the following categories:
    • Data providers such as Bloomberg, Refinitiv or MSCI
    • ESG specialist or research firms like Sustainalytics or Carbone 4
    • Asset managers with ESG expertise in data, ratings and analytics
    • Credit rating agencies like Moody’s
    • Stock exchanges like London Stock Exchange
  • ESG data vendors should aim to provide a qualitative layer on top of their ESG ratings numbers
  • It is anticipated that sell-side institutions will incorporate ESG data in their company specific fundamental research

Across numerous studies, climate change has been noted as the top issue for investors when considering ESG issues. Carbon-efficient indices provide climate metrics with focus on EU climate benchmark regulations. The Opimas study did note some shortcomings in this particular area – namely, the lack of certain data like Scope 3 emissions and the absence of standards to estimate the indirect carbon emissions. Without the standard, it becomes challenging to compare ESG data of two different companies and come out with an accurate investment analysis. And, without the proper tools to complete the database, its difficult to identify which companies successfully integrated the environmental, social and governance risks that improve returns.

How Asset Managers Implement ESG Integration in their Investment Decisions

  • Fundamental Strategy – ESG data used to forecast financials (such as revenue, operating cost, asset book value and capital expenditure) or company valuation models (including the dividend discount model, the discounted cash flow model and adjusted present value model) for the expected impact of ESG factors
  • Quant Strategy – construction of model with ESG factors and other factors such as value, size, momentum, growth, and volatility
  • ESG factors and scores can be used to build a portfolio to create risk-adjusted returns, reduce downsize risk, or enhance an ESG risk profile
  • Sell-side Research – broker research includes ideas and investment themes to integrate ESG factors into investment recommendations (BUY/HOLD/SELL) and into forecasted company financials like revenue, cost, asset, liabilities or models
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