Why ESG data comes up short

As Polestar talks to more and more private equity houses, private investors, and a companies in many industries, we know that an ESG policy is one that comes up in many proposals, information memorandums, and management meetings. 

We have written many articles on why it is so important to have ESG in a company’s business plan -focusing on environmental policies, demand, and valuation; it is now all about sustainable investing.

However, there are a lot of key barriers to sustainable investing, the biggest being a lack of well-documented ESG data that’s preventing true scaling and mainstreaming. But why exactly do investors need ESG data, and what to they do with it?

The World Resources Institute held a series of conversations with investment practitioners and found some interesting perspectives on why ESG data is so important, which I have included here:

  • Just as investors use traditional financial data to evaluate business performance, they use ESG data to evaluate the sustainability context of investments. ESG data include any indicators that shed light into the sustainability context of an asset, facility, company or region, whether historic, current or expected.
  • Investors, for example, may use ESG data to assess environmental matters like annual carbon emissions, regional water stress or whether a company has an emission reduction target. Under the social umbrella, ESG data covers issues like workforce diversity, gender equity and human rights, while data on governance topics tracks matters like corruption, labour practices and gender composition of the board.
  • Depending on the investment objectives, this data can inform various stages of the investment process, including asset allocation, security selection, portfolio construction and risk management. The additional layer of information can reveal material risks and opportunities that are otherwise overlooked in investment decisions, helping to identify investments that may lead to enhanced risk-adjusted returns and reduced downside risk.
  • ESG approaches are most widely applied in public equity assets, though there has been increasing attention in other asset classes, particularly fixed income.

Where do investors gather ESG data?

  • Most ESG data comes from companies’ public disclosures. Companies disseminate this information through a number of outlets, including annual reports, social responsibility reports and ESG disclosure surveys from data agencies like CDP. Investors can and do get relevant information directly from these sources. Third-party data providers also collect and aggregate these data, along with data from other sources. The providers serve as a centralized access point for data (see chart below), offered through fee-based subscriptions.
  •  Providers use their own proprietary methods to process and standardize the data into a suite of metrics, scores, ratings, rankings and indexes to enable easier comparisons among companies.
  • Many investors said they subscribe to multiple providers to benefit from their unique comparative advantages.

What is currently wrong with ESG data?

  • Poor coverage across holdings: The available data are incomplete, making accurate assessments across a portfolio difficult.
  • Inconsistent reporting metrics: The fact that sustainability reporting is voluntary makes for messy data.
  • Poor quality, immaterial: Investors have substantial doubts about the quality of sustainability data.
  • Inconsistent evaluation with limited transparency: The ESG scores, ratings and rankings from data firms are of questionable validity.

Now that we know the background, it is obvious that the market is missing a big, reliable type of software that can gather all of this scattered data and make it user friendly for investors. Working at Polestar, I know how important data is to value a company. The ESG market is slowly developing, but will not be complete until the data is.

“Investors are struggling to figure out what to do about climate risk.” – traditional asset manager

By Anusheh Khan on 29/11/2021