Investors risk placing “too much confidence in the data”, industry experts warn.
Relying purely on quantitative ESG metrics from “the now” is skewing assessments and predictions of capital risk and materiality, according to two groups of panellists at Reuters’ two-day ESG Investment Europe 2020 event, held November 2-3.
Investors need to evaluate where data has come from and, more importantly, when, as integration of ESG factors into investment processes should be regarded as a long-term objective, not be influenced by short-term market performance.
“Current data streams are backward-looking,” said Gabriel Wilson-Otto, Head of Sustainability Research at BNP Paribas Asset Management. “There is a data lag and subjectivity around when these issues will be priced by the market – not all investors understand that you cannot rely on data on its own.”
Asset managers and owners need to assess ESG metrics on investee companies “not ‘as is’ but ‘what will be'”, added Richard Tomlinson, CIO of Local Pensions Partnership Investments (LPPI), who chaired one of the discussions.
Kris Atkinson, Portfolio Manager of Fidelity’s Sustainable Reduced Carbon Bond Fund, said managers may choose to invest in companies with low ESG metrics to encourage or enact change from within, or because they see potential in the future model.
“I am much more transition-focused; I am looking forward,” he said. “That means I am happy to run with higher carbon emissions if I think [a company’s] performance on ESG will improve in the long term.”
Investors must also consider the qualitative factors surrounding quantitative ESG inputs, panellists highlighted. When considering climate-related risks, for example, managers should have in-depth conversations about a company’s carbon footprint, its strategy for achieving emissions targets in both the short and long–term, and an examination of existing practices and how these compare to their competitors.
This qualitative overlay can provide context, helping to reduce prevailing levels of overconfidence in quantitative data, said panellists, noting inconsistencies across third-party ESG sources.
Without a qualitative grounding, “you can almost create the answer you want from the data,” said Daisy Streatfield, Investor Practices Programme Director for the Institutional Investors Group on Climate Change (IIGCC). Explaining the why behind the data through quantitative inputs will ensure all parties are on the same page, panellists said, as regulators and industry-level groups continue working towards more comparable, actionable and standardised data.
Disclosures on greenhouse gas emissions are becoming more standardised as more companies adopt the recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD), while broader voluntary sustainability reporting standards are being harmonised under the aegis of the IFRS Foundation. Further uniformity of ESG-related disclosures is expected when the EU’s new Sustainable Finance Disclosure Regulation (SFDR) – also known as the Disclosure Regulation – comes into effect from March 2021.
Panellists also noted difficulties arising from separation between traditional and ESG-focused data, disclosures and processes. By divorcing ESG factors from other considerations, as can happen when ESG is not fully integrated into the investment process, investors are at risk of not seeing the full picture.
To combat this, investors should be working to “integrate ESG into their materiality assessments”, said Cindy Rose, Head of Responsible Capitalism at Majedie Asset Management. As with other aspects of risk, “information impacts our conviction levels and our trading always follows,” she added.
LPPI’s Tomlinson attested to the attention now being placed on ESG factors in asset owners’ investment processes. “I spend a significant amount of my time – up to 25% to 30% – on issues surrounding ESG,” he said. Yet he and the other panellists admitted there remains a lack of consensus around how ESG analysis should be integrated with more traditional risk assessments “There needs to be more sophistication around how ESG integrates with investment processes,” Tomlinson acknowledged.
Better quality and more standardised data will allow for greater consensus around ESG integration and analysis, but asset managers will always need to be flexible when catering to client demands, Rose suggested.
“I don’t think there is a best approach – there are approaches best suited to different clients. There needs to be a place for everyone to meet,” she said.