What Motivates Investors to Use ESG Data?
The UN-PRI was one of the initial large-scale organizations to put forth the concept of ESG, and from 2005, the idea has gained traction globally. Since then, an increasing number of institutions have ascribed to the idea, and by 2020, the number of signatories to the UN PRI grew from 100 to over 3,000, with total assets under management of about USD104tr.
Source: UN PRI
According to a report by Morgan Stanley (2016), the dominant drivers for adoption of sustainable investment practices on behalf of asset management firms are:
- client demand (29%)
- financial return potential (15%)
- personal values of leadership (10%)
An investor survey conducted by a professor at the University of Oxford in 2018 shows that investors use ESG information because it is financially material to investment performance. Moreover, European investors believe more strongly than US investors that engagement with companies can bring change in the corporate sector to address ESG issues.
Among the motivations, a significantly higher percentage of large-firm respondents than small-firm respondents gave strategic financial reasons, such as a growing client demand or as a differentiator when looking at similar companies. “When we look at a company, we don’t look at it only because it’s doing well on ESG, but if we have two potential companies, we might be thinking about investing in, if one company has exemplary governance and another doesn’t and we have a similar upside in both, of course we will always favor the company that has better governance,” said Nicholas Melhuish, head of global equities at Amundi. In contrast, retail investors are more likely to see the consideration of ESG information in investment decisions as an ethical responsibility.
For investors, ignoring ESG factors is to ignore risks and opportunities that have a material impact on the returns delivered to beneficiaries. ESG principles underpin almost all aspects of the buy-side investment decision-making process.
Barriers to ESG Data Use in the Investment Decision Process
When State Street Global Advisors polled 300 global institutional investors, it identified that finding financially material data was the most significant challenge for those integrating ESG criteria into their investment process. Currently, the buy side has yet to agree on how to harmonize their investment strategies and ethical responsibilities.
Another challenge is how to do it quantitatively, which could make it easier to bring into the investment process. Measuring ESG performance is important for investors, but it is also very difficult for investors. Especially, when investors invest in small and micro-cap companies, a lot of those companies don’t have big investor relations (IR) departments and therefore have not embarked on preparing documents that might help smooth the investment decision-making process.
China also faces many challenges in integrating ESG practices among corporates and investors. “China has no mature experience in applying the international ESG assessment framework and standards locally.” Said Katherine Han, head of ESG Research of Harvest Fund Management. “China market should improve the current market conditions, information disclosure, data availability, data quality, and investors’ investment philosophy.”
An overview of how an asset manager such as Harvest Fund uses ESG data
Harvest Fund Management is an asset management institution based in China, and one of the first-moves in building its own ESG ratings and investment framework. With three main pillars, eight sub-categories, and 23 indicators, as well as 110+ metrics, Harvest uses its ESG rating system to evaluate ESG risk exposure and opportunities that Chinese listed companies face.
Harvest uses a team of seven analysts to do its ESG research. Due to insufficient ESG data quality in the market, the company seeks to supplement this through in-house research, ESG data scientists and investment analysts.
At Harvest, the investment team oversees its ESG research and integration program. ESG analysts contribute to ESG research via inputs into Harvest’s ESG model. The model’s output includes ESG scores and insights utilized by sector analysts and portfolio managers in their investment decisions. The ESG scoring framework measures the performance of a business’ operation and governance as it relates to financially material ESG issues facing a company’s industry. Also, Harvest analyzes ESG performance from a portfolio perspective and based on the data, will consider underweighting or divesting from significant laggards.
Harvest also claims to use artificial intelligence (AI) in its processes. AI is used to extract and process the unstructured data the company comes across from a variety of public sources to improve data quality and granularity. It specifically uses natural language processing (NLP) to monitor and categorize ESG topics.
Amir Amel-Zadeh, George Serafeim. Why and How Investors Use ESG Information: Evidence from a GlobalSurvey. 2018, 74(3):87-103.
Lars Kaiser. ESG integration: value, growth and momentum. 2020, 21(1):32-51.
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