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ESG & New Factors

ESG investment data has evolved dramatically in recent years, and is arguably worthy of greater investor attention as its usefulness continues to escalate. With the market’s growing appetite for effective investment tools, more and more professional investors are using high quality ESG data as part of their investment process to better mitigate against corporate risk and to potentially increase their alpha.

The evolution of ESG data

Up until recently, the usefulness of ESG data has been notoriously challenging due to the lack of established frameworks in this relatively new, global segment of investment analysis. In addition, the quality of the ESG data available has been determined by corporate and country disclosure which has created a natural barrier to quality ESG data being available across the entire market.

However, this is changing fast. To start with, we are seeing a dramatic increase in sustainable investment flows as investors increasingly view the sustainable investment universe as a necessary overlay to the investment process. The world has become more conscious in many ways, and institutional and individual investors are voting with their assets.

In addition, savvy investors are becoming more sophisticated in the way they manage their investments. As such, they are becoming more aware of the tools which could help them better manage their investment risks, and potentially increase their alpha. This quest for better investment tools has led to a boom in demand for alternative data sources. There are numerous examples of alternative data sources being used more by the investment world in recent years including geolocation data, credit card transactions, satellite imagery, web scraping, internet activity, sensors and devices. For example, satellites are being used to follow the number of cars in manufacturers’ parking lots to provide insight into how busy the company is. Any piece of data which may help manage investment risk is in strong demand.

Risk management with potentially more alpha

With the demand for new data, and the shift to ESG investments - there has been growing demand for quality, differentiated ESG specific data in recent years, as it is increasingly being used to identify high quality businesses. Most recent analysis suggests that companies which score highly in ESG factors also generally score highly in other high quality metrics. The reason is intuitive - managing ESG risk is a key systematic and idiosyncratic risk which all businesses face, and strong management teams are generally more effective at risk management.

MSCI recently announced research that shows portfolios with strong ESG factors outperformed through the coronavirus financial selloff earlier this year. Once they excluded the obvious defensive factors of quality, low volatility and underweight energy factors, they were still left with a “big chunk” of the active outperformance which was directly linked to ESG factors. Whilst this analysis covers only a short period of time, the dramatic March selloff was arguably the biggest test of data factors we’ve seen since the Global Financial Crisis. So this is compelling evidence that ESG data helps contribute to better risk management and improved investment outcomes, and explains why high quality ESG data is in such high demand.

The growing ESG data demand trend is escalating in 2020 thanks to the coronavirus. The Financial Times and Savanta, a market research company, recently surveyed UK fund managers, and almost 90% of them believed that the coronavirus crisis would lead to an increase in ESG investment interest, which is likely to lead to further growth in ESG data demand. This connection was well articulated by Rob Morgan from Charles Stanley recently,

“(It’s a) reminder that we are all part of something much bigger and we have to think of others, not just ourselves. That feeling can also be reflected in our investments through socially responsible investing, so there is a direct link.”

Larry Fink from Blackrock agrees. In his 2020 letter to investors, he wrote passionately about the need to incorporate ESG analysis in all investment portfolios. When you think about the amount of assets that are held (and effectivley voted) by Blackrock - its policy impact can have a huge effect in the way companies manage themselves to attract capital.

“Purpose is not a mere tagline or marketing campaign; it is a company’s fundamental reason for being – what it does every day to create value for its stakeholders. Purpose is not the sole pursuit of profits but the animating force for achieving them.” – Larry Fink’s annual letter to CEOs, 2019

Morningstar recently wrote a report entitled “ESG makeover for investment industry”, in which they highlighted the strong connection between corporate profitability and key ESG data such as safeguarding customer data, prioritising environmental sustainability, developing a positive culture and ensuring high supply chain standards. Investment interest generally follows company profitability so these are examples of ESG data points which are likely to help contribute to improved investment outcomes looking forward.

New tools

In an environment in which professional investors are demanding new innovative investment tools, demand for more sophisticated ESG data is expected to grow strongly in the coming years. Already, there is alternative ESG data available which introduces new factors for investors to utilise, and which can be used to mitigate against investment risk.

So how does an investor access the alternative ESG data which creates the most value? ESG Analytics is a great example of the alternative ESG data providers meeting this growing demand for useful ESG data, particularly alternative data which can’t be accessed anywhere else. The company is creating and tracking non-traditional data sources to measure corporate ESG strategy implementation, and to ensure capital can be allocated efficiently with a clear view of where companies are heading with their all-important ESG strategies in the future. Importantly, the company’s data helps to mitigate against company risk and in doing so potentially improves investment performance, the key goal for most investors.

It’s an exciting outlook in the ESG data world. Looking forward, investors can expect a lot of growth in the types of ESG data available as it becomes more widely understood that high quality ESG data helps improve investment risk management.