ESG data still lacking – but investors adapting through in-house frameworks
Portfolio-level ESG data tells only a part of the story and so investors are incorporating information from several providers into their assessments, guided by in-house frameworks.
The promise of data for tackling some of the worst effects of climate change was a regular discussion point at COP27. One area where the available technological solutions have already gained significant traction is environmental, social and governance (ESG) data for sustainable investing.
In the lead-up to and during the conference, global data giants including Bloomberg and MSCI announced new sustainability datasets – sustainable bond indices and climate action indices, respectively. Meanwhile, on November 14, the Global Resilience Index Initiative, a public-private partnership, presented its risk-demonstrator tool, the result of its work on developing a common language for understanding climate risk in financial terms.
These announcements cap off several years that could be described as a goldrush for sustainability and ESG data.
For investment funds and investors alike, this ESG data landscape is becoming increasingly complex, while regulatory requirements and the unfolding climate crisis make it vital to engage with the development of assessment frameworks. As a result, sophisticated institutional investors are opting for several providers and incorporating the data into an in-house framework to bridge any gaps. The gaps in portfolio-level data can be numerous.
A recent webcast organised by consultancy EY suggested that investors believe that ESG disclosures often miss the context – information that grounds a metric within the business model, scale or geography of a company’s operations.
“For example, you could have the exact same reported metric from one company that means great performance, and the same metric for another company in the same industry can mean poor performance; the difference between the two could be scale, location or degree of vertical integration, among other factors,” states Brian Tomlinson, managing director, ESG, at EY.
“Effective use of disclosed ESG data by investment managers requires knowledge and judgment — the type that is based on deep industry experience. Single data points and scores are unlikely alone to tell a useful story about ESG and its connection to financial performance.”
You could have the exact same reported metric from one company that means great performance, and the same metric for another company in the same industry can mean poor performance.
From portfolio to strategy to process
For ESG-conscious investors, portfolio-level data tells only a part of the story. Most will incorporate data from several providers into their assessments for direct and indirect investments, guided by an in-house framework.
And when it comes to the complex and sometimes opaque assessment of an externally managed strategy, the most sophisticated investors will apply a layer of qualitative assessment to evaluate a fund, strategy or process within its respective geographic and industry context.
ABN AMRO, which manages €43bn in sustainable investments as of 2022, uses data from several external providers – most notably Morningstar for investment funds, as well as Morningstar-owned Sustainalytics, of which the Dutch bank was a founder company and sold its 4% stake in 2020.
According to Vincent Triesschijn, head of sustainability, this quantitative data – applied to direct investments and manager portfolios – is only the first layer of assessment, and is enriched by several rounds of quantitative assessments conducted in-house.
“We have a manager selection team based in Paris, as part of our asset management organisation, ABN AMRO Investment Solutions. They screen our external investment funds, by means of both a quantitative and qualitative analysis, Treischijn tells Net Zero Investor.
“On top of this, we always conduct a qualitative analysis which focuses more closely on the management company of the investment fund.”
These layers of analysis are needed to marry and enrich disparate ratings frameworks from various providers, and to contextualise the portfolio-level risk analysis based on specific manager strategies, according to Triesschijn.
What makes the difference is the qualitative assessments, so not so much the scoring and the number crunching, but much more when you sit with the manager to see what kind of convictions this person actually has.
ESG vs impact
In ABN AMRO’s framework, the sector, geography and materiality approach of a manager is key to informing the weighting of different datasets within a quantitative ESG assessment.
“It’s impossible to generalise our weighting across sectors – each sector will present its own considerations and intricacies, which will make provider scores more or less relevant. We also believe that you should have your own view on the weighting for asset classes, large-cap versus small-cap investments, whether the strategy in question is thematic or not. Generally we have a lot of levers we can adjust,” says Triesschijn.
“From my perspective, what makes the difference is the qualitative assessments, so not so much the scoring and the number crunching, but much more when you sit with the manager to see what kind of convictions this person actually has.
“Are they more focused on risk and applying what we refer to as single materiality – focusing on financial and operational risk for the company? Or does the strategy apply a double materiality lens – focusing on the effects of the company on the world from an environmental and social point of view?”
Triesschijn notes that both approaches have a place within ABN AMRO’s fund roster, falling within the remits of Articles 8 and 9 of the Sustainable Finance Disclosure Regulation (SFDR). Article 8 covers funds that promote environmental and social characteristics, but do not classify these as an overarching objective, while Article 9 regulates funds that explicitly use sustainability goals as their main objective and aim for positive impact.
Alongside other Dutch and EU investors, the bank has been employing SFDR definitions ahead of schedule – reporting against the EU regulation began in early 2022, while the technical standard is due to come into effect on 1 January 1 2023.
Many, if not most, European investors now have Article 8 and 9 funds within their portfolios, and, as such, access to an additional layer of data on the sustainability of portfolios. Around €2.5trn in European fund assets is estimated to sit under these categories, with this number expected to grow in the near term.
In the current volatile and challenging geopolitical landscape, investment funds across the board, including those classified as Article 8 and 9, have seen substantial outflows and some losses. According to Morningstar research, Article 8 funds bled €28.7bn in the third quarter. However, this is less than the updated €31.6bn in the previous quarter.
Article 8 funds – those that employ single materiality and seek to minimise impact – also held up better than their Article 6 peers (those funds that do not integrate any element of sustainability into the investment process), which saw outflows worsen to €62.1bn in the third quarter.
Meanwhile, investors continued to demonstrate confidence in Article 9 products, as these registered €12.6bn in net inflows.
