Shoddy data is the single-biggest stumbling block to a wider adoption of environmental, social and governance (ESG) strategies among institutional investors, a new study by State Street Global Advisors (SSGA) has revealed.
The SSGA survey found that for “nearly half of respondents, the current state of ESG data — single sourced, low correlation and confusing terminology — is a hindering factor to accurately assessing the credentials of underlying companies and their portfolio-level impact”.
(ESG data reliability was, however, less of a concern for Asia-Pacific investors who ranked the factor seventh out of nine, well behind their chief worry – costs and resource limitations.)
According to the SSGA report, the bespoke research and scoring methodologies of the many ESG data suppliers has left many investors bewildered. In a separate study of some 30 ESG research vendors, SSGA found little correlation between the ratings of the same underlying companies by different providers.
For example, the SSGA analysis of two largest ESG data suppliers – Sustainalytics and MSCI – “determined a correlation of only 0.53 among their scores, meaning that their ratings of companies are only consistent for about half of the coverage universe”.
The result has particular implications for index investors who remain hostage to the biases of their chosen ESG researcher “in terms of data acquisition, materiality, aggregation and weighting”, the study says.
“Institutions that have implemented ESG for index-based strategies (for equities and fixed income) are most concerned about the consistency of ESG data from different providers — inconsistent ESG scoring approaches between data providers creates challenges for such investors as they try to target and track certain outcomes from their ESG investments,” the SSGA report says.
However, active investors are most concerned about the quality of ESG data compared to traditional research.
“Well over half (63%) of index investors are most reliant on the main ratings agencies,” the study says. “This is in stark contrast to active investors, at 39%. In fact, 47% of active investors rely on in-house research (versus only 26% of index investors).”
Aside from data disappointments, respondents ranked poor resources/high costs, lack of expertise and a conflict with fiduciary duty as the main ‘pull’ factors restraining ESG growth.
Curiously, the study also found – in almost equal proportions – that fiduciary duty was one of the major factors pushing investors towards ESG.
“It seems for some there’s a lingering concern that ESG adoption may hinder the ability to maximize returns,” the SSGA report says. “Despite this, there does seem to be a clear trajectory towards ESG increasingly being considered a key part of fiduciary duty.”
As well as fiduciary duty, growing regulatory pressure and risk mitigation are driving ESG adoption, the SSGA study says.
Ben Colton, SSGA head of asset stewardship APAC, said in a release: “The research results confirm what we’re hearing from our clients.
“The regulatory environment is clearly driving institutional investors towards a sea-change in ESG practices. Over the past year most of our clients have explored what they can do about their portfolios’ carbon profiles and climate-related risks.”
But the survey found most investors don’t rate ESG for its performance-enhancing qualities… yet.
“Investors aren’t primarily motivated by a view that ESG will drive outperformance, perhaps since evidence is limited at this stage given the challenges of attributing performance to ESG factors,” the report says. “And, some ESG pay-offs will be realized long term.”
The SSGA study says despite a number of pull factors dragging on ESG adoption, the push power is driving overall growth in the approach. Since a similar SSGA survey two years ago, funds managed to ESG principles grew by about a third, the report says, to top US$30 trillion, equating to “over a quarter of the world’s professionally managed assets”.
“As institutions try to respond to these competing forces — without compromising their risk–return requirements — they must chart their own course,” the paper says. “This means finding a best-fit approach to incorporating ESG factors into their investment process and balancing cost pressures with the need to build up specialist knowledge.”
The SSGA report – titled ‘Into the mainstream: ESG at the tipping point’ – surveyed more than 300 large institutional investors across the globe covering “private and public pension funds, endowments, foundations and official institutions”.