Data is not the be-all and end-all of ESG

Gemma Woodward – Head of Responsible Investing at Quilter Cheviot – recently published the following article in ESG Clarity.  

The rapid rise of responsible investment has necessitated an increased demand for reporting on ESG metrics and factors. But with this increased reliance on data comes the danger that, in what would seem a paradox, we actually get a murkier picture of the performance of a portfolio in relation to ESG factors.

At Quilter Cheviot, we often see reports produced by investment firms using third-party data which rates a portfolio or a fund based on ESG metrics, and more often than not this rating is better than the benchmark.

Most importantly of all, for discretionary investment managers at least, the work undertaken by research teams to consider ESG factors across asset classes, as well as engaging and voting on monitored universe holdings cannot be incorporated into any score that is provided by a third-party ESG data provider.

The rating will be a static figure, a one-dimensional rating. Thinking about ESG involves much more than this.

This is particularly true if we think about stewardship. This is about engaging with companies and funds to understand the ESG issues that impact them, and voting (where applicable) to ensure positive stakeholder outcomes. Engagement topics vary enormously, they will include climate transition planning, remuneration, board composition, corporate behaviour, disclosure as well as thematic discussions.

Engagements are rarely one-off in nature, they can often span months and years. It is the ongoing dialogue which allows us to hold companies and funds to account that can make so much difference

Using a metric from one external provider is simply a number and it is hard to discern how that fits into portfolio construction.

Then there’s the issue of data gaps. Often when portfolios are given a rating, not all the assets will have actually been assessed if the data provider does not cover all the holdings within the portfolios. The score therefore may not reflect the true position of the portfolio.  

While receiving a ’gold star’ ESG rating for your investment portfolio might give you the feel-good factor, in our view, it can be misleading and not a true reflection of the breadth of the responsible investment work being undertaken by the investment manager.

Change is afoot in 2022, as the FCA are developing proposals for an investment labelling regime, which will eventually result in a standardised product classification system to help consumers understand the sustainability characteristics of different products on the market.

While the clarity this will provide is extremely welcome, it really will only provide clarity for product-based solutions. It will not be possible for the discretionary market to apply individual labels to discretionary managed portfolios, which often number in the tens of thousands.  Therefore, the conundrum for us is how to provide clients with the assurance that we are integrating ESG into our decision making. Of course, we have our own view on how to do this, but others would be very welcome!

Article first published in ESG Clarity, January 2022.