Feature
was a response to a general absence of ESG data and filled the gap created by a growing focus on financially-material sustainability issues. “We want to be sure that we are focused on the ESG topics that are financially relevant,” Zandbergen says. Also setting its own scores is Aon, although its ESG ratings are focused on fund managers. They assess a manager’s awareness of ESG risk and how well they factor that into building portfolios. The system is simple. Managers with low awareness are given a 1 rating and those with high awareness are awarded a 4 rating. The data is compiled by 100 people across the world spotting the most suitable managers for its clients’ needs.
“Our ESG ratings process is an extension of that broader research process,” Manuel says, who describes assessing the capabilities of fund managers as the firm’s “bread and butter”. “We want to see ESG considerations feature throughout what a manager does, from their investment philosophy, to their process, to the way they incentivise their people, to the way they assess risk and demonstrating that through to the portfolios that they build. “Our ESG ratings are an assessment of process,” Manuel adds. Significant revisions to ratings are usually made annually, when companies typically disclose information about their operations. There are also quarterly tweaks based on news-flow, such as a scandal, but the main changes are made annually. “Quant investors find ESG the slowest-moving dataset in the world,” McAllister says, adding that resilience is a characteristic that sustainability-focused investors need because it is difficult to accurately reflect the sustainability profile of a company in a sim- ple score.
Please, sir, I want some more?
Of course, these ratings benefit from companies releasing updates on the non-financial performance of their business, but the level and diversity of such disclosures is disappointingly low. Corporate disclosure on ESG issues is “getting better”, according to McAllister. The main areas where disclosure remains an issue is in emerging markets and small and mid-sized companies. Employee and client satisfaction are metrics that, McAllister believes, have been correlated with future performance. “These are the areas that I look for but often find lacking,” he says. Understanding what senior management are incentivised by is also of interest. Other areas that need improvement include envi- ronmental disclosure.
There is criticism that this is backward looking, rather than stating what the future environmental-linked risks to the business are. So access to suitable data is an issue when setting ESG ratings. “The underlying data is extremely sporadic and of low quality,” Manuel says. “That means company level ESG rating systems rely on esti- mations and extrapolations. “So there is a low correlation between company-level ESG ratings
The investment industry is in the middle of a tidal wave of change in that there is a demand for integrating sustainability into all investment portfolios. Mark Lewis, BNP Paribas Asset Management
that are applied by different providers,” he adds. “The methodolo- gies are so substantially different because they are trying to get around these data challenges in different ways.” It could take pressure from shareholders to change how compa- nies report information. “My guess is that we will end up with a two-pronged approach, one for financial reporting and one for ESG reporting,” Childe says.
Early days
ESG ratings are predominately a gauge of risk and it appears that when it comes to assessing opportunity there is a lot of work to do. McAllister says that assessing opportunities in ESG is usually based on simple statistics, which is a problem. He gives an exam- ple of an agency giving an emerging- market bank a high ESG opportunity rating because a large proportion of the population are unbanked. “What the rating will not say,” he adds, “is how much competition the bank has, how much pricing power it has, what regulatory issues it faces and, crucially, is growth already priced in? “That is a good example of a blunt assessment of opportunity expressed via an ESG rating, which highlights where the ‘buy side’ has to do a lot of work,” he says.
Childe adds that risks and opportunities in ESG ratings should be treated as “two sides of the same coin” when integrating sustaina- bility factors into your investment decision-making. Manuel concludes by referencing research Aon published that highlights why ESG is important, not just for the planet and soci- ety, but for those looking to make a return, too. “One of the most important findings for me is that companies who are getting bet- ter at ESG are the ones who are showing some of the best financial performance.”
May 2020 portfolio institutional roundtable: ESG 21
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