ESG Investing: One Vision, Many Lenses

Many firms found a common starting point with the “E” (environmental) pillar. Spurred by the signing of the Paris Agreement in 2015, many firms have been integrating data sets, scores, and rankings on climate-related criteria. They’re analyzing data points on potential investments related to greenhouse gas (GHG) emissions, water safety, and climate action. This data is well researched and made available to investment managers to use as factors in their investment decisions.

But as we all know, ESG encompasses more than just the environment, and many asset managers and asset owners have incorporated metrics to assess a potential investment, such as those offered by the UNPRI, which comprises six Principles and 17 supporting Sustainable Development Goals (SDGs). As the graphic shows, SDGs provide an opportunity for entities to demonstrate how they have incorporated not only climate change-related issues, but also those related to “S” (social) and “G” (governance), such as ending poverty, improving working conditions, and increasing board diversity ─ all with the vision of “… responsible investment and to benefit the environment and society as a whole.” (Source: UNPRI)

But what happens when conflicting views arise as to what’s beneficial to the environment and society ─ or determining the best way to implement these actions? Rhetoric and opinions come into conflict, and even political polarization may impact what makes an ESG investment “good.” The answer to these questions could vary depending upon the investment itself, the interests of the client, and good old-fashioned interpretation.

For example, the overall ESG score for a particular investment may be average ─ high in one pillar but lower in another. Case in point: A company is recognized for diversifying its board but hasn’t addressed its climate targets as planned. Some companies may also focus on one area while ignoring another ─ all within the same pillar. For example, a company may implement a water quality initiative, yet irresponsibly manage its use of electricity.

What type of “E” score should that company receive? And while many companies may agree that ending poverty is a good thing, Company A may approach it through contributing to education (potentially impacting its “S” pillar score), while Company B might focus on supporting clean water initiatives (potentially impacting its “E” pillar score).

Layers upon layers of ESG data exist, making it difficult for ESG data providers to assess the right contributing factors, weights, and trade-offs. But this also impacts the asset managers and asset owners that not only need to assess the data vendor scores, but then put them into context to meet their clients’ requirements. As an example, according to a recent Forbes article, based on a leaked U.S. Supreme Court draft overturning Roe v. Wade, certain companies have reacted publicly. These companies’ reactions could be interpreted as positive news to some clients and negative to others. Likewise, the attorney general from Arizona recently opined about certain negative impacts of what may be well-intentioned climate initiatives.

We never thought that the politics of ESG would create such points of contention. Understanding “E,” “S,” and “G” through the different lenses is complex work, driving investment managers to source additional raw ESG data in order to develop a deeper view. Teams are also scrutinizing data, calculation methodologies, and AI algorithms. Screening lists and techniques are being assessed to both meet ESG compliance and avoid issues with client guidelines.

We can all agree that making the world better is a good thing, but how to accomplish that through ESG investing while meeting fiduciary responsibility poses challenges for asset owners and asset managers. ESG is here, but what’s considered “successful,” “complete,” or “good” depends on the lens you’re looking through.

On June 22, we teamed with VerityRMS, and were joined by Neuberger Berman, for a Vendor View webcast to discuss the latest technology in research management and the impact of ESG. Cutter members can access the replay.

For more on this topic, or to speak with a Cutter analyst or consultant, reach out to us at [email protected].