Mapping the Growth Trajectory of ESG Investing

After years on the fringe, sustainability concerns and those involving social, environmental, and governance (ESG) issues are now firmly part of mainstream investment thinking. To find out where ESG investing is headed, Jackie Murphy of GLG’s financial analysis events team held a teleconference with Libby Bernick, who is the CEO of Impact Cubed and formerly headed sustainability at Morningstar. There, she led a strategy to integrate ESG and climate analytics into a variety of investment products including indices, credit ratings, digital platforms, and fundamental research. The conversation, edited for clarity and space, follows.

What is your view of the current state of ESG adoption in the capital markets?

I’ve been working in this field for about 25 years, and the last five years have seen extraordinary growth. But we’re still only in ESG’s early days. Despite all the talk about ESG, there is still confusion about what it is and quite a way to go before it is fully adopted and integrated across capital and commodity markets. Even in equities, great variance exists by global region.

With so much data that can be incorporated in an ESG evaluation of any security, what do you believe are the key data points — and maybe some of the intangibles — that are particularly pertinent when assessing a company’s ESG performance?

What we’ve learned over time is that when you are assessing ESG risk, some metrics are more material than others, depending on the industry sector or region. For example, a food and beverage company would find water use much more relevant and important, and financially material, than a professional services company. The Sustainability Accounting Standards Board (SASB) has a materiality map that’s a good starting point for understanding which of those data points make sense or are potentially material for an industry sector. That said, carbon- and climate-related risks are becoming very important for all companies, regardless of sector, to consider. There are also many new policies that have to be developed around data security and diversity, equity, and inclusion.

What’s your view on the current state of ESG ratings?

It’s important to understand the difference between ESG data a company discloses and the subjective ESG rating that a third party creates based on that company data. ESG ratings have significantly improved and become more transparent over the years, and they’re continuing to evolve. At one time, there was concern that the ratings were a black box. And some ESG raters have taken steps to be more transparent with their data and methodologies. They also recognize that certain issues are more relevant or material to some sectors than to others.

Some of the remaining challenges with ESG ratings is subjectivity and outdated information. The data companies disclose could be at least a year old, so it can be very challenging to compare ESG information side by side with financial data that might be provided quarterly. The vast majority of companies don’t yet disclose environmental or social performance data. As a result, many of the ESG ratings are based on estimations or industry averages. What’s more, an ESG rating is essentially an aggregated average of hundreds of data points, which means that a lot of the extreme highs and lows are being averaged out. An investor may not be able to get a full picture of the company from its rating, and it’s important for the investor to have objective data on the funds and underlying securities.

How serious are all those issues?

The lack of consistency in corporate ESG reporting frameworks is a problem. It’s a barrier to scaling and mainstreaming ESG adoption across the capital markets. Without consistent global requirements, companies can pick and choose what they report. Most companies don’t report any quantitative data, though that’s beginning to change. Standards setters and regulators are talking about more standardized data from companies, and some stock exchanges are asking listed companies to report in a standardized way.

But, even when we have standardized data from companies, it’s unrealistic to expect there will be just be one way to assess ESG performance. Just as we have hundreds of measures to assess a company’s financial performance (for example, margin, or P/E ratio or working capital), it’s likely there will be many ways that investors assess ESG performance. For example, Impact Cubed provides a curated set of objective ESG data that asset managers then use to create their own expert rating or view on a company’s ESG performance and impact.

What questions should investors and others be asking about ratings?

Here are a few key questions to ask:

First, what’s the rationale behind the rating? Is the rating evaluating how much exposure there is to ESG risks? Or could it be evaluating how well a company is managing risks? Or is the data evaluating how much a company is creating positive environmental and social benefits? It’s important to understand the different reasons for a particular rating.

Second, are the ratings comparable across industry sectors? For example, if a tech company gets an A+, is the metals and mining company that gets an A+ rating being evaluated on the same scale? Some ratings are comparable across industry sectors and other ratings aren’t.

Finally, it’s important to understand how much information the company being rated has disclosed. If a company doesn’t disclose information, how is that missing information being estimated? It’s important to know whether there are data gaps and, if so, how the rating companies are filling in the gaps.

What are your thoughts on the best practices for measuring and reporting on ESG investment success?

Well, in my mind, the best practice really is that the story about ESG needs to be backed up by data. And for that, two things must take place. One is that the company needs to be able to explain how and why environmental, social, and governance issues are relevant to the business strategy and revenue model. Then they have to back that up with hard data on ESG performance. There’s got to be both the data and the story, and that’s often missing. ESG performance has to be seen and evaluated right alongside financial performance risk and return.

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About Libby Bernick

Libby Bernick has worked for the past 25 years to help businesses and investors understand climate-, ESG-, and sustainability-related risks of investments. She is currently CEO at Impact Cubed, a UK-based company providing ESG analytics and investments for building more sustainable portfolios. Prior to joining Impact Cubed, she was the Head of Sustainability at Morningstar Inc., responsible for integrating ESG into all of its business lines. Previously, Libby was a Managing Director at S&P Global, responsible for creating and commercializing ESG data to help investors understand financial implications of climate, environmental, and social factors. Prior to this, Libby was senior vice president at Trucost (which was acquired by S&P Global in 2016), and was responsible for the North American business unit. She is currently a member of the advisory board to Quotient, whose technology provides quantitative, traceable ESG data for commodity producers and traders, and RS Metrics, which creates geospatial ESG data that provides enhanced asset-level insights on risk.