The integration of environmental, social, and governance (“ESG”) considerations into investment programs is a topic where numerous industry participants passionately disagree. Many asset owners, particularly in the US, believe ESG considerations potentially violate fiduciary duties to maximize portfolio returns (by limiting the investable universe) and may also erode local economies if investments in certain industries are banned.
At the same time, many other asset owners care deeply about the merits of ESG and feel it should be widely adopted within their fund’s investment programs. However, these funds often struggle to quantify the degree to which their managers are actively integrating ESG ideals, and desire a better understanding of the social, environmental, and governance construct of their portfolios.
Regardless of a fund’s position on ESG, most asset owners lack transparency and have limited tools to track whether fund assets are being invested consistently with their priorities.
In this regard, a primary obstacle they face is that almost all ESG-related data consists of raw metrics. Consequently, both asset owners and managers must have the internal resources to collect and aggregate the data, as well as sufficient internal subject-matter expertise to consume the raw data and assess whether follow up is warranted. A further constraint, for asset owners in particular, is that current ESG due diligence on fund managers is typically limited to soliciting feedback directly from those managers with no means of independently assessing and verifying the efficacy of the responses.
A potential solution to these challenges is the use of ESG ratings. ESG ratings are intended to assess how well each company is addressing its respective ESG risks. In theory, practitioners can utilize these ratings when building and/or exercising oversight of investment portfolios. Unfortunately, as discussed in greater detail below, the firms that provide ESG ratings often yield very different rating assessments on the same company. This lack of consensus has historically limited the value of using any single rating provider and undermines investor confidence in the validity of their assessments.
Happily, recent industry developments offer quantitative solutions that now enable practitioners to develop prudent investment decisions and oversight policies based on those ratings.
This whitepaper is divided into four sections. The first section summarizes the growth of ESG and evolution of an ESG regulatory framework, including more recent resistance to what some view as imprudent ESG-activism. The second section describes the historical challenges of measuring and monitoring ESG data and the new quantitative solutions to these problems. The third section reviews the various positions and policies that asset owners hold with respect to ESG oversight. The final section describes key insights and benefits associated with ratings-based quantitative ESG oversight.
“Information is data endowed with relevance and purpose”