ESG is on the rise in investment policy ...
Asset managers are in the process of integrating ESG (Environmental, Social and Governance) criteria within their funds in a more intense way notably as:
- policymakers push fund houses to take greater account of ESG in their investment objectives. The European Commission’s sustainable finance action plan has proposed measures aiming to increase asset managers integration of sustainability factors into their investment processes.
- institutional investors are increasingly exposed to impact investing (reputational risk management, risk-adjust returns, RSE reporting considerations…). Over half of institutional AuM ($59Tn) have already incorporated ESG criteria or intended to do so in the near future. According to GIIN's annual impact investor survey, 225 institutions invested $35.5bn in impact investments last year, a jump of nearly 60% from 2016.
- individual investors’ interest for sustainable investing is growing around the world. 64% of active retail investors increased their allocation to sustainable investment funds compared to five years ago [1], with a relative greater interest from millennials and women, which are expected to hold respectively $24Tn and $22Tn of private wealth by 2020.
For further details about ESG market, trends and best practices, see Business Intelligence study.
... but structured data are inconsistent
As ESG increasingly becomes a major criteria in the investment field, firms need to access accurate and comparable information, which could be difficult because:
- ESG reporting practices are heterogeneous between sectors, companies and asset managers; analysis remains subject to subjective interpretations due to a lack of standards.
- as investments in emerging markets, alternative and private assets are on the rise (notably in institutional impact investing [2]), traditional “inside-out” data - disclosed by companies - are not available as a result of low disclosure and the absence of legal obligation.
- the vast majority of data available on companies is unstructured. It is estimated that 90% of all the data in the world has been generated over the last two years [3] and a growing part of them doesn’t come from traditional sources.
New sources and technologies are expanding
To complete traditional analysis, new technologies are able to identify and extract relevant sustainable contents, both quantitative and qualitative, from many sources (company reports, social media, regulatory filings, market research, news publications) and identifies macro and micro patterns for the end-user. Artificial Intelligence, Natural Language Processing and big data are transforming the ESG industry, providing investors with a greater supply of more timely information and the ability to develop more sophisticated investing strategies.
Asset managers have already detected the importance of this mutation and the way it will affect the impact investing market. Investors estimate that big data collection and analysis is the most important technology for the field over the next three years.
For the moment, ESG alternative data are mostly used by institutional investors as a research tool to find investment opportunities. 60% of asset managers and nearly three-quarters of hedge funds are using social media and social-driven news feeds as part of their investment process [4]. As 90% of investors using alternative data saw a return on their investment, institutional investors started to incorporate new information sources in their ESG research process.
AXA Rosenberg – the California-based equities division of AXA (€20bn AuM) – has begun using language-processing algorithms to scour company reports and news articles to track companies displaying the best approach to ESG. One of the first projects Rosenberg has worked on is to build out a dictionary of ESG-specific words and keep track of how many times these appear in company reports and filings.
“Alternative data sources will be a more important indication of where earnings are heading" (Axa Rosenberg Global CIO)
Large pension funds (GPIF, APG, PGGM), the World Bank Group, or Allianz GI have also started to explore alternative data sources as part of their efforts to refine their ESG analysis. Particularly, at the beginning of 2018, APG acquired Deloitte data analytics team for sustainable investing, known for its expertise and knowledge at the cutting edge of artificial intelligence, big data, and sustainable investing [5].
A new generation of services is ready...
Fintechs have taken a lead by calculating companies' ESG scores, ranking and indexes based on alternative data analysis and a 'filtering' process, excluding inconsistent data. Methods, number of covered companies, etc. are different but they all pledge to help investors integrate ESG data into their investment solutions with the goal of delivering enhanced investment results and positive social impact compared to benchmarks.
TruValue Labs' products provide advanced analytics to create usable and real-time sustainability metrics for better investment decisions. To address the issues facing existing ESG data, TruValue Labs developed Insight360, a comprehensive database able to parse big data and provide ESG analytics across six categories: Leadership and Governance, Product Integrity & Innovation, Environment, Workplace, Social Impact, and Economic Sustainability. The software can give a score for each of the SASB [6] factors for over 8,000 companies. In May 2018, the company announced it had closed a $13.6 million funding round.
OWL analytics is a data and index provider founded completely in sustainability. It scores and ranks companies against their peers across 18 core metrics, including 12 key performance indicators that quantify company behavior important to society. It covers a wide 25,000+ companies and its clients representing AuM $2Trn. They are also providers for the leading European information company IPE (Investment & Pension Europe) or the German index provider Solactive.
Arabesque is a global asset management firm. Its 'S-Ray' solution combines over 200 ESG metrics with news signals from over 50,000 sources across 15 languages through machine learning and big data. The tool rates companies on the normative principles of the United Nations Global Compact and, additionally, provides an assessment of 7,000 of the world’s largest companies’ performance on financially material sustainability criteria. In 2014, they released a report which identifies a correlation between high ESG quality and financial performance.
... and traditional providers have started to equip their offer
Most advanced companies in alternative data integration are still ESG analytics providers. Main actors have enhanced their offering with the launch of new applications that enable buy-side professionals to analyze real-time ESG data and incorporate it into socially responsible investment decisions.
State Street for example has incorporated new measures in its data analytics service, particularly for fixed income and alternative assets, where there is a gap in the amount of ESG data available compared with equity funds. The approach is focused on the analysis of media sentiment with the aim to be “predictive not descriptive”. The securities services company also partnered with TruValue Labs to improve availability and transparency of ESG data for investors. With this partnership, State Street will gain access to one of TruValue Labs’ ESG signals which identifies sustainability issues at the industry level. State Street also announced at the end of 2017 an agreement with Arabesque to complete this partnership.
Thomson Reuters has enhanced its ESG offering on Eikon, its next-generation solution for consuming real-time and historical data, enabling its users to make more efficient trading and investment decisions across asset classes and instruments. Developed by TruValue Labs, ‘Insight360’ complements its existing ESG offering by providing real-time access to material, relevant data and events related to sustainability and ESG statistics for over 7,500 publicly-traded companies.
Deutsche Bank Research has launched a new interactive web tool that uses big data and Natural Language Processing (NLP) to quantify the importance of ESG issues, as well as other intangibles such as stock market information, human capital, innovation, brand value and management quality. The new tool, labelled a-DIG, is the first product from a broader data initiative within Deutsche Bank Research – dbDIG – which looks to leverage alternative data and Artificial Intelligence to provide data-driven investment solutions.
A way to develop new ESG strategies
Does this approach provide added value compared to traditional ESG analysis? Latest studies estimate that the ESG approach achieves better long-term returns. Back-tests realized by Truvalue Labs conclude that companies with strong information flow, good overall ESG scores and positive ESG Momentum Score, calculated using its methodology, outperform the S&P 500 benchmark over a five-year period (assessing that it would add about 3% to 5% of alpha annually).
However, it’s difficult to say if the performance would have been greater with another rating method. The main advantage of that approach is to be repeatable even if structured data are lacking.
It also opens the way for new ESG investment processes such as more tactical and reactive strategies - traditionally difficult in ESG because of the slow pace of change, accentuated by the lag in reporting data - or quantitative-driven processes, with a systematic evaluation of companies.
Author: Pascal Buisson - June 2018
[1] Schroders survey (2017) - [2] According to GIIN's annual impact investor survey, impact investing assets of survey respondents totaled $228 billion, with 56%, of that allocated to emerging markets - [3] IBM Marketing Cloud report (2017) - [4] Greenwich Associates Survey (Q3 2017) - [5] Cerulli - July 2018 - [6] Sustainability Accounting Standards Board
