Since the UN Principles for Responsible Investment (PRI) launch in April 2006, sustainable investing has grown steadily and firmly. European and North American Institutional investors quickly embraced sustainable investing in much more significant numbers than in other regions. However, the trend has also grown in emerging markets during the last few years, so now there is a concerted global effort to collect ESG related information and utilize it in the investment decision process.
Estimates suggest that around $30 trillion of assets invested worldwide currently rely on ESG information, a 34% rise since 2016. The numbers testify that ESG ceased to be just a nice-to-have and has become an essential element of investment decision-making and strategy creation for business growth.
However, not everything about applying and considering ESG principles in investments is clear-cut. There are many ambiguous areas, especially when collecting ESG data and scoring managers by ESG engagement. Investors are increasingly applying these mostly non-financial factors as part of their analysis to identify material risks and growth opportunities.
Recently, ILPA (Institutional Limited Partners Association) have illustrated the need for improved data. ILPA is in the process of updating its DDQ template to reflect enhanced practices and new norms. The DDQ focuses on many aspects, including the transformation of technology, operating techniques, and industry best practices. The ESG section has been an essential part of the ILPA DDQ template since 2013, and the latest changes in the template place ESG at the forefront.
How is ESG data defined?
As the relevance of ESG engagement continues to grow for investors, managers are facing increased complications. For example, recent estimates predict that over 5,000 different alternative data sets will be available by 2024!
So how are professionals navigating this challenging environment and leveraging the additional insights?
The first challenge in assessing managers by ESG criteria arises because the term “ESG data” includes a wide variety of metrics – from air quality and water use to strategy and ethical behaviour, etc. Most of them are unquantifiable. Second, ESG factors are often interlinked, and it can be challenging to classify an ESG issue as only environmental, social, or governance. Finally, you cannot view ESG data in the sense of “one-size-fits-all.” A metric relevant for an energy-focused company, such as water or land use, most probably doesn´t carry the same weight for a company with a different industry focus.
Given the diverse nature of the potential data sets and the fact that it is impossible to standardize the data across strategies, the first step in assessing managers´ ESG engagement is to define which data sets are relevant and set the parameters specific to individual requirements.
Challenges of sourcing ESG data
The standard way to collect ESG data is via annual reports, managers´ websites, social media accounts and PR activities.
Investors need access to independent sources to get an unbiased overview with accurate, consistent, and credible data. Independent specialized company reviews involve significant research and resources.
Alternatively, Investors could employ their own forces in collecting targeted and timely ESG data through appropriate DDQs and technology tools.
How to structure diverse and descriptive ESG data?
How to structure and then correctly compare diverse, often descriptive ESG data? Which benchmark to choose with data whose values are relative to the context and circumstances of an individual manager?
Standardization and interpretation of collected ESG data is another pain point in performing managers´ assessments. Manual standardization of data, reducing them to a common denominator, and interpretation of such processed data almost always leads to inaccurate results, not to mention the time-consuming and costly process.
Investors can employ a variety of analytical approaches and data sources. Also, understanding the relative merits and limitations of different metrics certainly helps form a more comprehensive picture of ESG opportunities and risks.
Only technology can help in the meticulous structuring and analyzing this diverse and unstructured data.
What is the best way to analyze ESG data?
As there is no standardized approach to the different ESG metrics calculation and so many interconnecting factors, the methods of analyzing ESG data can make or break all the efforts taken when collecting and structuring the data.
Lack of standardization is where dedicated and flexible technology solutions come into focus – to help draw conclusions about ESG related aspects and make grounded decisions.
The following steps can be helpful in performing an efficient and consistent ESG analysis:
- The data collected must be made uniform and structured for comparison. Digital platforms can constrain the response to fit a specific numerical, text, date or general answer format.
- Often ESG questionnaires are designed for long-form answers, and these require a great deal of time to spot the signal from the noise. Whenever possible, these questions should be converted to multiple-choice or direct short answers.
- Some answers must be allowed to remain long-form. The key to these sections is to utilize algorithms to compare the year-over-year change in the answers to spot if a manager or GP has changed a process in a meaningful way.
- The structuring in parts 1-3 allows a system to automatically flag and score answers so the analyst can focus their attention on the interesting insights from the questionnaire.
- The process for reviewing the answers must be structured to make sure every analyst is consistent in their review. Platforms can allow for structuring reviews, workflows and checklists for consistency.
- With everything done on a single digital platform, ESG reporting can be made simple. A digital platform can thread all the information into a consistent report that allows investment committees to spot valuable insight more easily.
Following the steps above creates a consistent approach to ESG analysis that can allow for a formal review of the process. All the information is in one platform, and then stakeholders can review a decision when performance or other information comes to light in the future. When scoring and monitoring managers by ESG engagement, investors need to be clear on what they aim to achieve. Digitization will help to focus efforts and not just collect the data for the sake of collecting. The process aims to be able to draw valuable conclusions and make intelligent decisions.
If you want to have an efficient, centralized process of collecting ESG data and precise scoring of managers by their ESG performance, check how Diligend solution can help. Book a demo or send us a message via the contact form.