The most persistent topic of discussion in sustainable investing is ‘when will the data be good enough?’
The challenge that sustainable investors have is that we want to be sure that we invest in sustainable companies – as well as get financial returns – while also being able to measure the impact (positive or negative) that these companies have on the world. A tall order.
In this discussion, we often fail to acknowledge that the origins of sustainable investing long predate the easy availability of environmental, social and governance (ESG) data, and we have more ESG data available now than ever before.
Come a long way
Investors’ have been investing according to their non-financial goals for a long time, doing their own research and making decisions based on the knowledge available to them.
Today, investors have easy access to a large and growing volume of reported ESG information, the alternative data market is exploding, and regulation will likely drive additional company reporting in the next few years.
There are still gaps, but we are undoubtedly better-informed than early sustainable investors. More data could even create new challenges, making it more difficult for investors to identify important indicators amid more noise.
Far from a magic bullet
Environmental and social data is often compared unfavourably to financial data. Critics point to global accounting standards, stock exchange listing rules, regulatory requirements for financial statements to be audited, and severe penalties for accounting fraud as reasons why financial data is superior.
However, financial data is not perfect either. There are enough examples of accounting fraud to know that if companies want to hide information, they will.
It is certainly true that the environmental and social metrics are harder to measure than cash flows. Differences in measurement definitions and the intangible nature of many environmental metrics mean mistakes and inconsistencies are likely, and comparability between measurements from different companies is hard.
Not perfect
However, even financial information has issues. Investment analysts always need to adjust their valuation models to reflect different business decisions around, for example, capital structure and acquisitions.
Additionally, fundamental investors do not make decisions based solely on financial statements. The financial numbers only tell us what happened in the past, but investors also want to know how the industry is likely to evolve and how peers are behaving. They want insights into what employees and customers think of the company in order to assess future value.
The same is true for ESG data. Backward-looking metrics only give us a starting point.
Subjective
Another criticism of ESG data is that ESG ratings are not in agreement. However, this is usually a misunderstanding of what ratings are. A rating is a subjective opinion, not an objective datapoint.
Again, we can compare ESG ratings to traditional investment recommendations to see the same dynamic at play. Investment analysts looking at a company all have the same financial information to start from, but they do not all arrive at the same investment recommendation.
Asset management (buy-side research) analysts know this, and do not take broker recommendations (sell-side research) at face value. Users of ESG ratings need to ensure they understand the rating methodology to ensure they are using the information in an appropriate way.
Minority investors always face the challenge of never knowing everything about an investment, so they have to estimate and make assumptions in order to predict the future performance of an investee company. This applies to both financial and ESG issues.
However, expectations of ESG strategies can be unrealistic – portfolio managers of sustainable funds who experience a ‘controversy’ in their portfolio are criticised far more than portfolio managers who experience a profit warning.
Only a tool
Ultimately, all data is only a tool for investment decisions, whether financial or non-financial, and interpretation of the data is much more important.
But, above all, we must not lose sight of the aim of sustainable investing. The collection of data in itself is not the end goal, and the pursuit of perfect data must not be an excuse for inaction.
Rachel Whittaker is head of sustainable investing research at Robeco
