The internet has put a wealth of facts and figures at everyone's fingertips—and in real-time, too. While highly publicized data breaches have understandably prompted concerns, the widespread availability of data has also emerged as a source for good. Investors and research analysts have increasingly found inventive ways to capitalize on newly available information.
This trend has proved especially true in the world of environmental, social, and governance (ESG) investing, which has grown substantially in recent years.
According to the Global Sustainable Investment Alliance's 2021 Global Sustainable Investment Review, at the start of 2020, sustainable investment reached $35.3 trillion in five major markets (the U.S, Canada, Europe, Japan, and Australasia)—a 15% increase in from 2018 to 2020 and 55% increase from 2016 to 2020.
“Data is the lubricant” behind the rise, as Stephen Franco, managing director of Socially Innovative Investing at Bank of America, remarked at the 2018 Total Impact conference. ESG data have become an essential tool for investors looking to gain a truer picture of how well a company is doing.
- An increase in available data has spurred the growth in impact and environmental, social, and governance (ESG) investing.
- ESG asset managers are capitalizing on a new swell of quantifiable information and analysis, with investors following suit.
- These new methods include the standardization of environmental, social, and governance factors.
- The data have helped debunk myths that ESG investments underperform, showing that many hold their own or even outperform their traditional counterparts—and offer less risk/volatility as well.
- The trend toward adding sustainable assets to portfolios is likely to continue as their market-rate returns can be proven.
In Search of Value
Historically, most investments have been chosen using a blend of qualitative (judgment-based) and quantitative analysis—which, in finance, refers to the process of analyzing numerical information to determine the health of a company.
Publicly traded companies are required to make quantitative information available through shareholder reports, which investors analyze to make observations and predictions about a company’s health.
Research analysts supplement company financials and key performance metrics with their own observations from earnings calls, informal conversations, and interviews with company leadership.
While this method was generally successful in helping analysts predict a company's value, the subjectiveness of the methodology frequently left risks—including environmental, social, and governance concerns—insufficiently analyzed.
According to Abdur Nimeri, chief investment officer for UMB Family Wealth and former senior investment strategist at Northern Trust Asset Management: "Environmental and social risk wasn't as embedded in the price [of equities] as you would expect.”
Moreover, staying up-to-date was difficult. "It used to be that we had a static view of the company,” says Jeff Gitterman, co-founding partner of Gitterman Wealth Advisors. referring to the quarterly updates that public companies are required to file. But big data and AI have broadened the landscape.
Today, data-driven methods are emerging to help analysts better measure this non-financial information. This data allows researchers to quantify the "complex interrelationships" among intangible, difficult-to-measure concepts that help predict company success, says Anders Ferguson, founding principal at Veris Wealth Partners.
Percentage of total global assets under management that are sustainable investments.
More Standard ESG Measures
These new methods include the standardization of environmental, social, and governance factors. Now, “there’s a blizzard of numbers,” said Bob Smith 503, president and CIO of Sage Advisory in Austin, Texas.
“You’re going to make decisions on the data that’s available,” says Anna-Marie Wascher, CEO & founding partner of Flat World Partners, an impact investing firm. As nonfinancial data grows more abundant, more and more opportunities will emerge to accurately price and factor in underlying risks at companies. Newly quantified ESG information is becoming a "necessary part of fundamental analysis,” says Stephen Franco.
Investors should still be careful. "The data is still immature," Franco cautions. "The raw input still has a long way to go." What's important is combining it with other factors. "Just like how only looking at a P/E ratio doesn't tell you much about a company, neither does a raw ESG score.
"These issues are now seen as material to company outcomes," he adds. "You're not doing your fiduciary duty if you're not looking at these statistics."
ESG: "The GPS of Investing"
Many investors once thought that impact investing was “just a fad," says David Alt, director of responsible investing at Victory Capital Holdings. Even just "two years ago, there was a lot more resistance to ESG and impact investments.”
That pushback is rapidly disappearing. Impact investing today is “much more accepted and tolerated,” says Alt.
That change is largely a result of data not only helping investors find information about companies, but also helping them to quantify the results of their investments. "There can be no buy-in…unless you prove that you're doing the job that you were hired for,” says Smith.
“ESG is the GPS of investing,” said Jeff Gitterman. Early ESG investors were only able to screen out companies with policies and practices that they did not want to support.
However, ESG data means that today’s investors have much more latitude to pick the causes that interest them and invest to meet an end. "You can't have a target unless you have something that you're aiming at,” says Jim Lumberg, co-founder of Envestnet, a financial data provider.
The number of sustainable open-end and exchange-traded funds (ETFs) available to U.S. investors in 2021, up 73% from 2020.
Sustainability Outpaces Traditional Investments
Even the best sales pitch is meaningless if managers aren’t able to deliver competitive returns. “Fifteen years ago, ESG investing could have been thought of as concessionary,” says Lumberg, referring to the idea that socially conscious investments underperform their traditional peers.
However, data has called that widely held belief into question. “Investing in sustainability has usually met, and often exceeded, the performance of comparable traditional investments… across asset classes and over time," researchers at Morgan Stanley’s Institute for Sustainable Investing declared in 2015.
A 2019 white paper by the Institute found that there is no financial tradeoff in the returns of sustainable mutual funds/ETFs and traditional funds, and that sustainable funds may offer lower market risk.
Lumberg says that, while the “academic world had debunked” the belief that ESG investing leads to sub-par returns, many investors are still wary. As environmentally and socially conscious funds have often outpaced their peers, frequently with lower volatility, that attitude may continue to shift.
Surveys such as Morningstar's annual "Sustainable Funds U.S. Landscape Report" have supported this conclusion. "Like any investment approach, sustainable investing will not always outperform over short-term periods. But over the longer term, ESG insights can help investors develop a more complete picture of a company, one not reliant only on financial indicators," Morningstar notes.
What Does ESG Stand for?
ESG stands for Environment, Social, and Governance. These make up pro-social criteria for certain investors who value such things over pure economic profit. ESG investors can screen for these criteria to identify those investments.
Do ESG Investments Outperform the Market?
Various industry and academic researchers have looked to see if ESG investments beat the market, and the answer is it depends. From 2012 through 2021, one study found that, all else equal, highly-ranked ESG stocks outperformed by 12%, but only in Europe; American stocks with high ESG scores fared no better than the broader market over the same period. However, over shorter time periods, ESG performance varies quite a bit, as the graph below shows.
Where Can I Find ESG Investments?
There are now several online resources that rank and score companies based on ESG criteria, such as MSCI's ESG Ratings. You can also look to ESG-focused mutual funds and ETFs.
The Bottom Line
While some investors will inevitably prove hesitant to make major shifts in their portfolios, it’s likely that the investment community’s trend of increasing sustainable assets will continue. "We can now prove that we can make market-rate returns in a socially responsible way," says Casey Clark, Deputy CIO, Global Head of ESG Investments, and Portfolio Manager at Rockefeller Capital Management.