​Style Research Digs Deeper on How to Invest in ESG

Joel Anderson  |

What is ESG? For anyone familiar with investing, the acronym for “environmental, social, and corporate governance” is a familiar one. It’s at the core of taking an approach to investing that factors in long-term sustainability, considering a range of risk factors surrounding a company’s environmental impact, social responsibility, and a transparent corporate structure that avoids conflicts of interest.

But ask again with a real emphasis on “is,” and it starts to get a little bit murkier. It’s one thing to acknowledge that a company’s value to its shareholders is tied up in a lot of things beyond its balance sheet and income statements. It’s another to actually translate that into a quantifiable, data-based approach to investing. How do you weigh short-term financial returns against long-term environmental risk when the very act of defining long-term environmental risk is so complicated?

That’s why data analytics firm Style Research has been hosting a series of seminars in Europe and North America to explore the topic of ESG and delve into what it really means to portfolio managers, investors, and advisors. The recent west coast swing in October saw Style research hit Seattle, San Francisco, and Los Angeles in events hosted along with Mercer (MMC) and RBC Global (RY). Equities.com got a chance to speak with Bernie Nelson, President, North America at Style Research after the Los Angeles event.

“There’s a perception that somehow financial data is somehow just cut from stone to five-decimal place accuracy,” said Nelson. “ESG, meanwhile, is thought of as this amorphous blob of very vague and intangible information. But the reality is it's not as black and white. Estimating intangibles has always been a part of the financial valuation of companies. Analysts look at all the hard data, but they still invariably have to put a wet finger in the air somewhere in their estimation and modelling. Our approach to ESG now is more about how to bring this new information alongside traditional investment analysis in a consistent way. Traditional investing strategies incorporate metrics that have been well researched and well understood for decades, whereas ESG is a nascent field. If you're a quant or a risk modeler, do you wait until the data shows signals in your models, in which case it's probably too late, or do you start working with it now, roll up your sleeves up and try to make sense of it? I think what is happening is that people are just saying ‘we think things are changing, and from a risk perspective we've got to incorporate some of this stuff, whether it's climate change or something else.’ These issues are having material effects on some companies.”

And it was that act of rolling up their sleeves and digging into what we can do with ESG now that drove Style Research to undertake this series of seminars.

“From the get go, we thought we should explore the ESG subject from the perspective of the consultant, the asset owner, and the investment manager” said Nelson. “What is their perspective? What are they talking about right now in ESG?”

Enhanced Analysis of Companies

The event in Los Angeles began with a presentation from Brian Fairhurst, Director, Advisory Solutions Group at RBC Global who decided to tackle the broad question of what ESG is by focusing in part on what it isn’t.

“It’s not socially responsible investing,” said Fairhurst. “It’s not confusing values or ethical goals into a portfolio that restricts your investment universe.”

But Fairhurst also spoke at length about the very real work of taking ESG and making it a fundamental piece of any effort at valuation.

“ESG integration is an enhanced analysis of companies,” said Fairhurst. “We're talking about adding in non-financial data alongside financial data. Non-financial data that should be material financial drivers down the road - 3, 5, 7 years down the road. It could be things like employee habits. We all know that matters in a company, but it’s a difficult thing to measure. It doesn’t immediately map to the price of sales. ESG is really a better understanding of risk and opportunity.”

“And at the end of the day, that’s really what it boils down to,” he continued. “Can you find consistent ways to apply this and measure its outcome?”

After Fairhurst, Nelson took the stage to dig into another challenge in integrating ESG into portfolio management: communication. Ultimately, even a very precise understanding of how ESG factors into understanding a company can prove futile when its importance can’t be conveyed to a client. Crafting messaging that makes the importance of ESG considerations to any portfolio clear has to be a pressing concern for any analyst or advisor.

“Really the bottom line is that there are currently still many approaches, and really just a lack of standardization in the industry,” Nelson said. “So, this noisy environment presents challenges and this is the reality that institutional asset manager’s face. A lot of asset owners are still confused about how to implement ESG. ‘What measures should we use? How do we go about a task that seems so overwhelming?’ We've even had conversations with some very large owners of public pension plans who are very vocal in the support for ESG, but who still admit to be struggling to really make sense of the data. They're struggling to find a consistent structure that they can validate and manage. And also, how can they report this information so that it can actually be understood by a board of trustees? At the end of the day, if you are going to invest in something, then it has to be evaluated and understood.”

Finally, Marina Batliwalla, Principal and Investment Consultant with Mercer, took the stage to wrap up the seminar with a look at some practical advice for constructing presentations around ESG themes and communicating the importance of ESG to clients.

“So how do we put this on to practice for our clients? And what does the framework for ESG look like in terms of balance? Firstly we need to have some beliefs,” said Batliwalla. “It’s very helpful to get everyone together because even on individual committees, people have very, very variable views on what this is and what really matters. So we like to have a workshop and determine an established place. ‘Do you have a policy and a process?’ Once you have determined the range, you need to document it and do that in a policy statement where you can incorporate it into an existing investment policy. Finally, in your portfolio, do you know the extent to which the advantages are identified in the ESG race? If you don’t, do you have ESG ratios to do this? You can even look at the real assets and overlay it with the data.”

For ESG Analytics to Succeed, Education is Essential

Bringing better awareness of the importance of ESG to the modern portfolio isn’t easy, particularly when measuring its precise impact continues to be difficult to convey. However, the importance of embracing this investing style only stands to grow over time.

Speaking after the event, Nelson reiterated that openness and transparency is essential to helping normalize the subject for the financial industry moving forward, and expressed his satisfaction that the recent round of seminars appeared to be giving the subject a platform for people to be open about what they understand and what they continue to be confused by.

“Let’s be forthright, let’s be honest about what does and what doesn’t make sense,” he said. “What are we understanding? What are we not understanding? So, I have been reassured by the fact that people are saying ‘you know what, I don’t get that. I don’t understand it.’ But there is a thirst to get better data and analysis. As a firm, we’re reassured by these seminars, and we are resourcing and moving forward with our ESG analytics, but we need to move forward quickly. There is a demand for more granularity, and it’s still really hard to communicate a lot of this stuff. So for me, this whole process been quite reassuring in that I believe we are heading in the right direction.”

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