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Profit vs purpose: Do investors need to sacrifice returns to reward strong ESG performers?

The view that this cannot be achieved whilst also taking action to excel from an environmental, social and governance perspective has been hotly contested as ESG has risen up the agenda.

As we mark the end of COP27, it is time to take stock of the state of ESG investment in 2022, debunking areas of complexity and confusion and plotting a path for meaningful impact in the future. 

ESMA to introduce rules on ESG fund names to tackle greenwashing

This dichotomy between profit and purpose has not been helped by the complexity of the space – there is much confusion around what ESG investment involves, how to measure it and whether the issuers of financial products claiming to be ESG investments are actually taking the right factors into account.

First, it is common to see the conflation of disparate terms, namely,  socially responsible investing, impact investing and ESG investing.

For clarity, socially responsible investing involves selecting or disqualifying investments based on ethical criteria e.g. screening out companies involved in tobacco.

Impact investing, by contrast, involves selecting companies achieving a social benefit goal like developing renewable energy resources.

ESG investing evaluates a company’s environmental, social and governance practices, selecting and disqualifying investments based on ESG performance.

In some cases, the lack of clarity around definitions has led to greenwashing – such as the misrepresentation of financial products as ESG investments when the investments underlying the products do not fit the criteria.

Regulators have weighed in on the topic throughout 2021 and 2022. In the EU, SFDR saw the reclassification of several funds.

Earlier this year in the US, the SEC proposed rules to govern how investment firms and advisers market ESG funds.

These introduction of these rules, which require that ESG funds invest at least 80% of their assets in ESG areas, led to BNY Mellon  being fined $1.5m for incorrectly marketed ESG funds.

Add to this backdrop of confusion the issue of sourcing timely and accurate data that allows investors to  evaluate ESG performance without bias.

The ESG intelligence or analytics traditionally used by asset managers and investment advisers to derive meaningful views on ESG performance are dated and do not comply with existing and emerging regulation.

The inadequacy of traditional metrics was made apparent when Tesla was removed from the S&P 500 ESG index recently.

For over two years, traditional ESG ratings for Tesla had consistently ranked the stock with an ESG rating of AA.

During this time, Tesla was reported as having numerous product recalls, labour disputes, lawsuits and environmental violations reflecting degraded ESG performance.

These reports were clearly not reflected in traditional ESG ratings.

There was a fundamental disjunct. 

How then do investors monitor evolving ESG performance?

Where do the answers lie as to whether a company’s environmental, social or governance practices have improved or degraded?

If equipped only with traditional ratings, investors will be unable to accurately evaluate ESG performance.

Is this lack of data forcing investors to choose between achieving returns and investing in companies with strong ESG performance?

In short, no. Investors are now beginning to recognise the role of alternative datasets in assessing ESG performance.

ESG managers: Poor data dogs strong investor demand

For example, many are now using alternative data sources, like our own, mined from tweets, news, forums and blogs, for intel on a company’s ESG performance.

This digital chatter offers insights into ESG performance that are uncensored and delivered without delay or company bias.

The graph below demonstrates how timely ESG performance intelligence from alternative datasets can help drive investment returns.

The portfolio – in this case ours – was rebalanced every 30 days – investments were selected within the S&P 500 based on the performance of a particular company relative to peers in the industry, sector, and index.

This performance was assessed using sentiment data mined from digital chatter and online reports of environmental violations, poor governance and/ or social practices.

As the graph demonstrates, Sentifi’s portfolio generated significantly higher investment returns than the benchmark.

Sentifi’s portfolio outperforms S&P 500

 

This proves that companies can deliver returns to their shareholders while also taking tangible action that leads their peers from an ESG performance perspective. The answer lies in the data investors are using to assess a company’s ESG performance.

Ultimately, asset managers and advisers need up-to-the-minute and actionable insights that accurately assess a company’s practices – mining online forums is a sure fire way of getting such timely and unbiased analysis.

Marina Goche is CEO of Sentifi

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