ESG as a Crystal Ball


This morning I attended an event hosted by MSCI titled Applied ESG Research: Making Capital Decisions Using ESG Research and Data. The panel included an analyst, actuary, asset manager, journalist and representatives from MSCI and the UN Principles of Responsible Investment (PRI). Here are the key points I took from the two hour conversation on how environmental, social and governance factors are used in investment decision making.

Importance of ESG is growing

Google analytics shows an increasing amount of conversation about ESG and in the last two years ESG has become much more widely spoken about in the press and endorsed by those in positions of power such as Prince Charles and Mark Carney.

A report released by the UN PRI earlier this year concluded that factoring in ESG is part of fiduciary duty.

However, there isn’t a correlation between ESG and out-performance, but then apparently no popular financial metrics have a correlation with out-performance.

Data quality is a problem

ESG data is poor, not assured and not comparable so difficult to expect analysts to make a judgement on it.

Some think that governance data is more robust but often it’s the same small group of people sitting on boards and ticking the boxes. Are we sure these people understand new risks and opportunities from issues such as technology and climate change?

But processes are the primary problem

Problem with ESG is that doesn't understand the process of what it's been trying to change.

Everyone feels motivated to change but nobody feels empowered to do so.

The investment community is reactive not proactive and ESG issues are only being factored in once a particular negative event has occurred.

Investment clients decide on a particular benchmark to outperform and then instruct an asset manager. This means about 80% of the decision on how and what to invest in has already been taken by the time the investment manager receives the mandate.

Fiduciary duty changed from being the decision of a prudent person to becoming a returns maximiser. This is part of the problem as the recognition and reward factors are misaligned if we want a sustainable economy.

We are using maths to try and prove something we all know, such as that climate change is happening. Somehow the maths doesn't move the dial towards change in investment behaviour. So we need to understand why the models are leading to people being unable to make the change we know is required.

Dashboards do not show the destination but do show where an organisation is going and they should include social indicators as well as economic.

Factoring in externalities is a start but actually we may need to change the whole system.

Everybody’s fault and nobody’s responsibility

Fiduciary duty and herd mentality means it is a difficult system to change.

Stock exchanges should demand ESG data and this is happening more in the emerging markets. Sustainable stock exchange guidance was released by the PRI a few weeks ago and apparently we can expect to see some announcements this week that will put pressure on the stock exchanges to change.

The buy side need to get more involved in lobbying as at the moment they are far outnumbered by the sell side. More investors need to engage on regulation around ESG and asset owners should see the benefit of asset managers being engaged in positive ESG regulations.

Engagement on ESG issues with the value chain can add to the alpha.

ESG is about seeing the future

We can’t just extrapolate the past to see the future. We need a different approach and a model that factors in discontinuities in the future, such as fossil fuel use or slave labour conditions becoming unlawful.

It’s a mistake to think that ESG can only add value to companies by investment analysts understanding. More important is how we can use ESG frameworks to judge impacts of changes in the macro economy.

The ESG industry has been about how “good” a company is in its operations, but increasingly it is about what a company provides in services and goods. Are they geared towards growth and do they have a social reason for existing? What is their purpose in the future world?

Research found that only about 40% of asset owners have an investment philosophy and its fair to say that most of these do not include significant statements about issues such as climate change of ethics.

Need to think about what a transition to a low carbon economy looks like. Then more questions follow as to how the company fits into that new world. So the more questions you ask the more have to think about and do. That is how risks can be turned into opportunity.

Turn risk to opportunity

Crystal ball gazing is something I am increasingly being asked about, both explicitly and implicitly. What environmental and social changes does commercial property need to factor in and how do businesses in this sector manage the risks and find the opportunities. I believe a robust strategy, education programme and process change can go a long way to answering these questions.


Bilfinger GVA are a member of the BBP's Managing Agents Partnership. Read more about this project here.