ESG ratings
are the areas that I look for, but often find lacking,” he says. Understanding what senior management are incentivised by is also of interest.
The danger with investing in companies with the highest ESG ratings is that you can overpay for an expensive stock that has a green premium or a halo. Lloyd McAllister, Newton Investment Management
Other areas that need improvement include environmental 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 that company level ESG rating sys- tems rely a lot on estimations and extrapolations. “So there is a low correlation between company-level ESG rat- ings that are applied by different providers,” he adds. “The methodologies are so substantially different because they try- ing to get around these data challenges in different ways.” It could take pressure from shareholders to change how com- panies 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
often deals with long-term criteria, such as climate change. “It is a slower-moving beast,” he adds.
Give us more
Of course, these ratings benefit from companies releasing updates on the non-financial performance of their business, but this is still in its infancy. Corporate disclosure on ESG issues is “getting better”, accord- ing 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
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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 example of an agency rating an emerging- market bank’s ESG opportunity as ‘high’, because a large proportion of the population are unbanked. Opening an account would ena- ble them to manage their finances better. “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 adds.
Childe adds that risks and opportunities in ESG ratings should be treated as “two sides of the same coin” when integrating sustainability factors into your investment decision-making. Manuel concludes by referencing research that Aon released that highlights why ESG is important, not just for the planet and society, but for those looking to make a return, too. “One of the most important findings for me is that companies who are getting better at ESG are the ones who are showing some of the best financial performance.”
36 | portfolio institutional March 2020 | issue 91
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