ESG investment rises, but tracking methods fall short
Lacking on environmental, social and corporate governance reporting
INSIGHT ARTICLE |
Investing in companies whose mission includes environmental, social and corporate governance (ESG) is growing in popularity but there is still no consensus among asset managers and investors on how best to report ESG performance. According to the Forum for Sustainable and Responsible Investment, ESG-managed investments represent $11.6 trillion of alternative assets, or one in every four dollars invested, up 44 percent from $8.1 trillion in 2016. ESG reporting–which tracks everything from a business’s impact on local community to its use of green energy–has been added to most due diligence questionnaires and the number of allocators requiring ESG has grown. An RSM US LLP report on corporate social responsibility found that 39 percent of middle market executives are familiar with ESG criteria to evaluate their own organizations. Yet uniform reporting requirements do not exist.
Companies that implement ESG practices are perceived to achieve better business results; investment managers have jumped on this trend and implemented ESG investment strategies at a growing rate. Approximately one-third of asset managers have at least one person dedicated to ESG investing, according to surveys conducted by Bloomberg. And investment performance isn’t the only motivator. Investment advisors pushing ESG are compensated with higher fees when they manage more capital; meanwhile, large endowments, pension plans and insurance carriers increasingly have ESG capital allocation targets as public demand for corporate transparency increases.
The emergence of millennials as the majority age group in the global population has pushed investing preferences toward companies with ESG initiatives. Millennials increasingly stress social impact alongside fiscal performance, so asset managers must pursue deals that are both financially attractive and simultaneously drive social change. According to Bloomberg, millennials are set to inherit some $30 trillion in the coming decades, indicating that this new investment preference is unlikely to change and that there is a clear business case for improved ESG reporting.
The 2017 CFA Institute's ESG Survey found that 67 percent of analysts want ESG data to be verified by third parties, but only a few providers actually take this step. There are several additional challenges, however, that need to be addressed before the widespread application of ESG data within asset management.
First, most managers self-report, which creates implicit biases for the type of information they are likely to share with investors. Because nearly all affect measurements fall outside of U.S. reporting standards, questions arise about the quality of the data being sourced. Without a standard framework, ESG measurement may be interpreted very differently from one business to another. Meanwhile, managers are incentivized to promote ESG practices as a marketing tactic rather than a measure of true social impact. Worse yet, it’s questionable whether investor due diligence is strong enough to unearth poor ESG behaviors.
THE EMERGENCE OF MILLENNIALS AS THE MAJORITY AGE GROUP IN THE GLOBAL POPULATION HAS PUSHED INVESTING PREFERENCES TOWARD COMPANIES WITH ESG INITIATIVES.
How to report ESG impact
The lack of authoritative guidance on which measurements or disclosures should be presented to investors makes it unclear how to best report impact. There is a stark difference between process-oriented reporting such as occupational safety and health practices versus quantitative reporting such as board diversity. Also, there are far too many ESG focus areas for one, or even a few, measurements to comprehensively apply. Topics such as safety, infrastructure, clean water, tobacco, climate change and gender diversity each warrant their own customized reporting and disclosure. Consider the annual report for a public company: it calls for certain standard financial reporting plus management discussion and analysis. One can argue that ESG reporting should be no different than public company reporting.
To be sure, the Sustainability Accounting Standards Board (SASB) was developed to identify, manage and report on financially material global sustainability topics, but widespread adoption by asset managers has not occurred. SASB standards were developed using extensive feedback from companies, investors and other market participants as part of a transparent, public-documented process. They have gained traction, with public figures like Michael Bloomberg advocating for them.
Notably, asset managers currently disclose internal rates of return and other expense ratios—financial highlights to help investors make business decisions. These financial statements do not include other important, nonfinancial information such as the mission, purpose or strategy of ESG practices, nor do they include measurements of environmental or social impact. Yet including such information would enable stakeholders to gauge performance based on a company’s ESG strategy and not merely on financial analysis alone.
Managers and investors stand to benefit from increased transparency regarding the impact of ESG investing and the social, environmental, and economic consequences of its strategies. Sharing this information helps managers and investors build trust in the marketplace, monitor and mitigate risk, and find other, more innovative ways to drive efficiency. This, in turn, drives a positive impact on financial results, the enduring purpose of all asset managers.