Methodology Shift is just the Beginning

Better ESG data already exist – you just have to look at things in a different way. The available methodologies for ESG research and analysis have ballooned under pressure from the events of 2020 and aided by a new, sympathetic, U.S. administration. After leaving the Paris Accord under the previous administration, the U.S. now stands poised to play a game of catch-up.

Regardless of intent, the financial community is participating in the intense rush to get on the right side of history. In 2019, the number of ESG-related funds increased dramatically. In 2020, that growth increased in both speed and scope.

Demand for new data helped cultivate a robust crop of new ESG-type data providers, analytics, ratings, and "gurus". Each new investment mandate requires a new data supply and a change in managers' perspective. Integrated analysis, which is just another way of saying, "now we're looking at ESG factors too," requires non-financial data to rise to the quality of financial data.

Unfortunately, as most participants in this market will admit, the standardized data is not here yet. Even though the demand has far outstripped supply, there is no easy way to scale up because the fundamental problems have not yet been addressed.

When the significant inflows into ESG ETFs, Mutuals, Hedge Funds, etc., began in earnest, the best data was used available at the time. Today, not much has changed. Besides a headline-making merger between two massive players in the data market, an analyst or PM's options are pretty much what they were a few years ago. With a few exceptions, the same big names that dominate other forms of data aggregation also dominate the ESG space.

What does that mean structurally? The same mechanisms, metrics, and ideas about how best to represent social and sustainability factors are in play today that have always been in play. Most providers employ large teams of analysts with a highly sophisticated and industry adopted methodology for collecting data, weighting its relative impact, and providing easy-to-use off the shelf scores.

Now more capital than ever before relies on these older forms of data collection. The increased usage has lead to increased scrutiny. No matter how accurate a particular provider's way of doing things may be, they still represent a disparate piece of a patchwork puzzle, which may or may not align with reality.

Critically, little insight into the make-up of the scores is possible, even when the scores themselves are as complex as can be.

Knowing More Means Doing More

Many financial community publications have covered the danger presented by a lack of consistent standards. The obvious judgments are available at first glance – different rating systems mean different conclusions, companies struggle to meet the conflicting standards, progress on key issues lacks cooperation, efficient capitalization of a better future remains a pipe-dream.

The UN SDGs and UNPRI are a global standard, no doubt. Big aggregators are often aggregated themselves by other aggregators, also providing a kind of global consensus. With more spent on data and more of these ratings available, the possibilities for looking at the problems are nearly endless.

The burden is on the financial community. ESG assessments are being incorporated into the Due Diligence process, but it is painstaking and expensive. Transparency is sorely lacking, unintentional green-washing is likely rampant, and even when the data is there, the structure often is not.

None of these issues have much effect on the insistent march of assets into ESG-rated funds. The authentic need for a better future means that most stakeholders are willing to expend the effort, whether in time or money, to adapt to this set of problems.

Ratings Dispersion and Disagreement won't Go Away Overnight

The outcome from this unprecedented push will not necessarily be better data. Without changing the approach and methodology, the core problems remain.

How do you know what you know? How do you confirm that it is accurate? How do you compare it to areas where data can still be sparse?

Today's market pressures are for making changes in the here and now, and rightfully so, there is no way to pause and wait until better ESG data is figured out. Market-level inertia alone will ensure that innovative solutions struggle to break out.

Most large money managers have entrenched data relationships. While it is true that alt-data is a robust marketplace, ESG data isn't really "alt" anymore. In fact, that is basically the entire point. To stop seeing ESG data as an alternative set, instead view it as a fundamental set. It is fundamentally tied in reliable ways to the business's future outcomes.

Finding Better Ways to Look Deeply into a Company's Impact

At idaciti inc., we do not provide ratings and scores based on opaque judgments. Our approach is less about measuring the presence or intensity of KPI and more about assessing what is actually there.

A scorecard on an ESG topic from idaciti will always include traceback to primary source documents. The rating or the score is only the beginning of the story. Seeing the traceback provides qualitative context to supplement the quantitative data. Additionally, transparency is baked into the schema. Each data point exists as a floating hyperlink that takes you directly to its location in the primary source.

Surprisingly, better data is literally already out there. Every single day this filing season, hundreds of companies respond in real-time to increased regulatory requirements.

What was commonly available yesterday will be swamped by what will be commonly available tomorrow. We are witnessing normative reporting standards develop in real-time.

This data needs to be assessed more than it needs to be aggregated. For instance, what do statements on diversity mean? Evaluating these in a vacuum is difficult in the absence of a normative standard. Comparing and contrasting company statements in real-time reveals a normative standard based on actual reporting as it stands today. That's the power of technology like idaciti's tagging and traceback. The norms you need for integrated analysis are already out there - we simply provide a way to see them more clearly.

References:

The dangers of sustainability metrics | VOX, CEPR Policy Portal (voxeu.org)

The Aggregate Confusion Project | MIT Sloan

2022 - The growth opportunity of the century (pwc.lu)

The Number of Funds Considering ESG Explodes in 2019 | Morningstar

How 2020 Revealed the Staying Power of ESG Funds (etfdb.com)

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