Investors increasingly embrace environmental, social and governance measures as a potential source of superior risk-adjusted returns. And that leaves advisors with additional challenges: identifying companies that manage ESG risks well, or selecting portfolio managers that incorporate ESG analysis as part of their process.
Some data providers, such as MSCI or Sustainalytics, generate scores for public companies based on their performance on ESG measures. But those scores are usually backward-looking and typically updated annually or semi-annually. They also are diverse; an examination of two leading providers found only 50% correlation and often an inverse relationship between the scores. This reflects the fact that these quantitative ESG scores are based on qualitative analysis, which relies on how important or material a particular practice or measure is considered to be.
Another challenge is the disclosure by companies themselves. For a portfolio manager, ESG issues such as water usage, worker safety and emissions can be tracked with publicly available data — but not in a consistent way. The data isn’t reported in a uniform manner across companies from year to year (as financial information is). The Global Sustainable Investment Alliance are trying to impose some standards of uniformity and coherence so investors can compare individual companies, but they still have a long way to go.
But assessing ESG performance requires more than a score. Many of the material issues that matter to responsible investors are not adequately reflected in quantitative scoring. They require a more nuanced analysis in the context of business strategy and enterprise value to understand the risks and opportunities embedded in a specific business. To truly assess ESG performance an advisor should complement the external ESG research with their own analysis, which may include directly engaging with companies to better understand how they are managing ESG-related risks and opportunities.