Data is critical to achieving full ESG integration

-

When formed in 2006, the global investor initiative, United Nations Principles for Responsible Investment (UNPRI) had 100 signatories representing $6.5 trillion in assets under management (AUM).

Over the course of a decade, the number of signatories has increased to 1,600 representing a tenfold rise in AUM to $62 trillion.
The three main drivers behind this surge are:

  1. Public policy: Changes in directives like the 2015 US Department of Labor ruling on ESG in ERISA plans reduced the limitations on pension funds looking to incorporate ESG issues in their process. In addition, the EU’s Non-Financial Reporting Directive has required 6,000 companies to annually report their ESG information since the beginning of 2016.
  2. Greater understanding: A growing number of studies have shown a positive relationship between ESG factors and corporate financial performance, supporting the premise that ESG improves financial returns for companies.
  3. Industry standards: The industry has made substantial efforts to develop much-needed standards for companies to measure and report on ESG performance.

But not everyone is onboard
Despite significant progress in investors’ understanding, hesitations remain. According to our research the primary barrier to full ESG integration is the absence of standardised, good quality data.
Almost two-thirds (60 percent) of institutional investors cited the lack of standards for measuring ESG performance, and more than half (53 percent) highlighted the lack of data available on ESG performance reported by companies as primary concerns.
This is understandable given that even if a company is producing a sustainability report— which many more of them are – it’s difficult for investors to find hard numbers on what ESG issues the company regard as important for shareholders versus stakeholders. To this end, a remarkable 92 percent of investors want companies to identify and report on the material ESG issues they believe affect financial performance.
This lack of data, however, directly contributes to the high level of misunderstanding that persists about ESG strategies in general and, in particular, about ESG integration.

Common misconceptions de-mystified
The three most common misconceptions often touted as barriers to ESG implementation are not as significant as commonly believed:

  1. “ESG integration means sacrificing financial returns”: Not true, a minority (35 percent) of institutional and retail investors believe ESG investment means sacrificing returns.
  2. “Fiduciary duty precludes ESG integration”: Only 10 percent of survey respondents view fiduciary duty as a barrier to ESG integration. Furthermore, 40 percent of asset owners and 51 percent of asset managers believe the concept of fiduciary duty is actually shifting toward encouraging ESG integration.
  3. “Performance expectations are too short for ESG integration”: Yet 75 percent of institutional investors expect outperformance in three years or more.

What next?
It is clear sustainability and climate-risk have become important factors for investors as they assess their portfolio holdings. However, for true ESG integration, it all comes down to data – data transparency, engagement and the goal of creating a future intelligent approach to investing.
For institutional investors, more efforts also need to be made to increase their knowledge of these strategies. Full ESG integration can’t be done when there is a sharp dividing line between the sector portfolio managers, the analysts who are only held responsible for financial analysis, and a separate (and usually small) group of ESG analysts who handle proxy voting and attempt to influence the decisions of the sector specialists.
ESG integration requires a strong degree of internalisation of ESG factors by the sector specialists and building the necessary expertise in them to do so. In other words, ESG needs to become part of the investment organisation’s culture and strategy.

Lou Maiuri – executive vice president – State Street Global Exchange and Global Markets