The ESG Holy Grail doesn’t exist… yet

Now that most of the buy side offers investment products that have some kind of ESG slant—whether impact investment funds containing a mix of assets such as green bonds, or equities portfolios that screen out major polluters—funds are looking to differentiate themselves. To do so, it seems they are going to want increasingly specialized ESG data: more data on public companies to bolster ratings, and data on private and emerging markets, where disclosure is thin or non-existent. 

In May, for an article on ESG start-ups that are looking to plug these data gaps, I spoke to Paul Sinthunont, a senior analyst at Aite Group. Sinthunont had just finished conducting a survey of about 50 buy-side firms from around the world, some large asset managers, others small boutique shops. He told me that all these firms are looking beyond the ratings they buy from the large data and index providers like MSCI, Morningstar, and Bloomberg. 

“Based on my research, the buy side doesn’t want to rely solely on ratings, even if they are a useful reference point. What they want is the underlying data so they can have their own view and build their own internal scores,” Sinthunont said. “They don’t want to rely on the same third-party providers as everyone else, because then they have no IP or thought process of their own.” 

The ideal ESG solution for buy-side firms would be a central platform they could consume ESG data alongside traditional financial data—that is the “Holy Grail,” Sinthunont says. But that doesn’t exist (yet?), so firms must content themselves with consuming data from at least two or three different vendors that can plug the various gaps that are left by ratings. 

As WatersTechnology has often reported, many of these gaps are the result of inconsistent corporate reporting. In developed markets, corporate disclosure has improved a lot: research by S&P Global found that in 2019, 90% of the biggest companies in the US published sustainability reports; in 2011, it was just 20%.

This improvement is partly in response to investor demand, and partly regulatory requirements. The EU’s Sustainable Finance Disclosure Regulation, for example, requires that firms source loads of really granular data on companies to calculate the impact of their portfolios and be transparent about what goes into their investment products. 

Even so, corporate reporting remains voluntary for the most part. In asset classes like real estate or private markets, there are very few ESG providers and no data standards. In emerging markets, ESG is in its early stages. For large buy-side firms, the data to measure risk and assess performance in multi-asset portfolios is not there. 

Firms attempt to fill these gaps themselves. Most recently, we wrote about how some funds are looking to raw data sourced from non-profits like environmental activist groups to inform their investment decisions, rather than relying solely on black-box ratings from data vendors. These investment professionals want to draw their own conclusions, and believe that to do that, they need the raw data from corporates that underpin their ratings, bolstered with data from the non-profits. 

As Mike Chen, director of equity and head of sustainable investments at PanAgora Asset Management, told us in May, “There’s no right or wrong [in ESG investing]; it’s like asking someone what their favorite color is. Therein lies the problem of using commercial ratings: you’re accepting somebody else’s opinion made for you.” 

Going back to the article I wrote that I previously mentioned, start-ups are also looking to provide more data where disclosures are thin and exploit niches in investor demand for ESG data, whether those be for private markets like data vendor Preqin does, or extracting quantitative intelligence from public reports like Net Purpose.

But it’s not just start-ups. Established data vendors are also realizing that there are potentially other markets to be tapped. Ice Data Services is one of these. 

In building its ESG offerings over the last couple of years, the company decided not to build any ratings products. This decision was made partly because there were already established players in that space, and partly because what clients seemed to really want was detailed information around corporate disclosures that they could dig into themselves, rather than a high-level view of risk, which is what a rating is, says Lynn Martin, fixed income and Ice Data Services president.

Ice has built sustainability indices, a product for climate risk assessment along with vendor Risq, and ESG derivatives data, among other products. During 2020, the company built out an ESG reference data service, in partnership with Bank of America.

Martin says that the company’s focus has been on public markets, but it will need a private markets solution by this time next year, judging by customer demand.   

“We are still developing a strategy for that,” she says. “We are focused more on the public markets, and are still building out the reference dataset to the quality that we wanted, so our focus was on tacking the largest, most well-capitalized companies out there first, and continuing with the view of moving into emerging markets and, even more, the private markets later.”

No doubt other large providers will be stepping into this breach also. As Sinthunont told me, they will have an advantage in their size and existing expertise. And many of the larger providers will look to snap up or partner with the start-ups. But whoever is supplying the data and however they do that, real estate, private markets, and emerging markets are some gaps that firms will be looking to fill as they race to retain a competitive edge.