The ESG Data Revolution

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Adam Bernstein, ESG Specialist with Gitterman Wealth Management in New York believes “We are experiencing a non-financial, ESG data revolution,” More than two decades of resistance to using ESG data in pursuit of portfolio performance is disappearing across the wealth management industry.  Bespoke ESG asset managers like Saturna Capital and diversified industry giants like BlackRock are sourcing ESG data from industry providers and their own research platforms. So are large and small broker-dealer and registered investment advisor (RIA) advisory practices.  

“I get calls from other RIAs every week,” says Bernstein “regarding how we perform due diligence on the 40 Act mutual funds owned in the firm’s SMART Investing strategies.” Other firms want to know what investors are demanding of this diligence process. This information helps RIAs in two ways: how to begin the ESG conversation with their own clients; how to shape their marketing message to be different from the competition.

The volume of information being reported to investors by corporations, and in turn, by financial data providers like MSCI, Morningstar/Sustainalytics, Bloomberg, Thomson Reuters and S&P/Trucost, just to name the major firms, is certainly robust. Sources include corporate annual and sustainability reports, portfolio analyst research, SEC documents and business media coverage.

Many companies’ performance related to specific ESG factors can now be revealed in a thorough due diligence process. The choice of which ESG factors are “material” to a company or industry sector, however, determines the value of that performance to financial advisors and investors.

Examples could be improvements in energy efficiency for commercial real estate,  reduced fresh water consumption in computer chip manufacturing processes. Valuable ESG data could also include the firm-wide percentage of women and minorities in senior management positions for banks or the pay scale and working conditions of employees laboring in overseas supply-chain garment industry companies.

Advisor Focus for Leverage

Financial advisors can focus on three things to leverage this rapidly growing ESG database across the seventy-nine industries for which the Sustainability Accounting Standards Board (SASB) has developed materiality metrics. First, begin having the ESG and Impact investing conversation with every client. This often provides an advisor with values-based personal information supportive of deeper client relationship building. Second, address each client’s issues related to ESG investment performance. Current investment markets data and over 10 years of industry studies have demonstrated that it is possible to achieve competitive and superior performance versus commonly used industry indexes. The third leverage point is to develop a comfort level with the ESG due diligence process. Raw ESG data must be aggregated to provide material, non-financial, points of comparison within economic sectors and industries.

Major data providers like MSCI and Sustainalytics have developed measurement scales for this type of comparison between companies, but the statistical correlation between these scales at the company specific level is about 20%. Firms like Gitterman Wealth Management use additional sources of ESG information and active engagement with fund managers to eliminate the “noise” and distill the ESG materiality signal down to its essence. Of course, this process must be updated at regular intervals to stay current with fund and client portfolio risk profiles, real-time company news and broader economic trends.

Since material ESG data at the company level is relatively new to the field of investment research, it’s important for financial advisors to have an opinion on the data providers as well as the funds and companies being analyzed. “You can score them on data collection, data analysis, data verification and the frequency of data updates. These processes are materially different across data provider platforms,” cautions Bernstein. “As fiduciaries, advisors have an obligation to vet ESG data with the same level of scrutiny they bring to balance sheet data.”

The ESG Specialist

In the RIA community, this calls for having a team member in the role of ESG Specialist. RIAs that have skilled people to own this role and the financial resources to develop it are in a right place, right time scenario in 2018. Assets under management (AUM) in ESG and Impact portfolio strategies continue to grow faster than industry-wide AUM.

Other RIAs may opt to focus on asset gathering and hire the ESG Specialist role out to someone that brings experience to this job. Bernstein has spent three years developing his position at Gitterman Wealth Management. “I vet several ESG asset managers per week, keep up with the expanding volume of ESG and Impact research and produce the monthly portfolio updates. Given the pace of growth in ESG investment opportunities alone, I think it would be difficult for someone not experienced in ESG data analysis to effectively build this process from scratch in 2018.”

This writer has been consulting with advisors for six years to support the integration of ESG and Impact investing into RIA practices. Every year the pace seems to quicken and potential opportunities have continued to grow for advisors and their clients. RIAs that want to participate in the economic benefits of the ESG data revolution should consider how the ESG Specialist role can best support and be supported by their business model.

 

The information, analysis, and opinions expressed herein are for general and educational purposes only. Nothing contained in this piece is intended to constitute legal, tax, accounting, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. All opinions and views constitute our judgments as of the date of writing and are subject to change at any time without notice.