07/12/2021

Using ESG data for real-world impact

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Introduction

How the launch of an innovative new ESG data platform can help investors strengthen their engagements and optimise their portfolios for real-world impact.

Demand for environmental, social and governance (ESG) data and tools continues to grow, with tailwinds from changing investor preferences, as well as regulation. Below, we summarise some of the benefits and use cases of the newly launched ESG for Investors platform, as well as the factors that users need to be aware of.

In summary, we believe that the platform equips users with tools that allow them to have an immediate impact with regards to engagement, stewardship and portfolio optimisation

Aiming high: the novelty of the approach

A focus on opportunity rather than risk

  • ESG research often focuses on downsides, such as quantifying the costs of future regulation and the magnitude of potential stranded assets. Instead, the platform chooses to focus on opportunities – in the form of potential shareholder value creation from adopting the practices of top-performing peers. We believe this pragmatic approach is more likely to resonate with corporate decision-makers and investors, by focusing on ESG improvements that research shows are valued by the market.
  • Whether the trade-offs between ESG objectives and financial returns are necessary or non-existent continues to be the subject of passionate, if often hypothetical, debate. By contrast, the platform’s real-world perspective helps to build common ground between actors whose sustainability preferences may differ, but who share a clear mandate for value creation, be they company executives or investors.

A focus on the most material issues

  • ESG topics are vast. At the limit, they are a ‘wish list’ of everything that could be improved in the corporate arena. Unfortunately, though, not all ESG themes are quantifiable and linked to a company’s bottom line. The platform combines academic research and statistical analysis to identify a combination of eight E, S and G factors that have the highest potential to improve shareholder value.
  • This can help drive immediate focused engagement around the topics that can make the most difference: the initial results of the ESG for Investors research suggests that over half of the potential shareholder value gains, on average, stem from companies improving performance on the two most material variables. For example, tackling carbon emissions matters more for the energy sector, for example, than for consumer goods. Equally, a bottom-scoring consumer goods company may be able to unlock more shareholder value by improving its emissions performance, compared to the upside currently available for an energy company that is already in the top 10% among peers. The platform aims to combine these two dimensions – sector- and firm-level materiality – allowing users to identify peers with best practices, and to quantify and compare potential improvements across issuers and industries.

Accessible to everyone

  • to ESG adoption in the market – costs (leaving investors unwilling or unable to pay for data) and transparency (with ‘black box’ approaches based on hundreds or more data points leaves companies unable to clearly identify where improvements are needed the most).

Combining risk-adjusted returns and impact: the next efficient frontier

  • Investor interest for ‘traditional’ impact investment in the public domain continues to grow, and regulation is putting more emphasis on quantifying and addressing the positive and negative societal impacts associated with mainstream funds. The platform offers investors tools to factor in impact considerations as a standalone dimension, alongside risk and return.
  • A suite of “3D portfolio optimisers” – currently one focused on climate change and one focused on impact investing – can help investors find an efficient frontier between maximising their impact (e.g. supporting the companies taking strong steps to reduce their carbon emissions) and minimising unintended consequences (e.g. correlations between asset classes that can negatively impact diversification).

Coming clean: some limitations of the data

Sole focus on quantifiable factors

  • By design, the platform focuses only on quantitative ESG metrics. There are instances where qualitative metrics have a role to play within an ESG framework. As an example, land-use rights in the mining industry may have a very material impact if mismanaged, but nevertheless are difficult to capture numerically. Moreover, there are unavoidable trade-offs, as selecting factors with cross-sectoral relevance means not all the specificities of an industry can be reflected in the analysis.
  • The platform is intended to augment, and not replace, in-depth research of sectors and companies. Its quantitative ‘bias’ aims to provide investors with data-driven insights to inform asset allocation and help prioritise engagement.

Relative vs absolute ambitions

  • Much of the analysis depends on what could happen if a company adopted the practices of its peers who scored in the top 10 per cent on a given metric. Given the wide variation in ESG practices currently existing in the market, this approach has significant potential to inform immediate changes within sectors, as it is rooted in improvements which other companies have already shown to be possible.
  • Conversely, the weight markets will ascribe to a given ESG factor in the future may differ from the weight it has ascribed to them in the past.  The platform illustrates the ‘low-hanging fruit’ that companies can harvest by moving more in line with the practices of peers. At the same time, investors may push the envelope further, by asking even top-scoring companies to step up, particularly if there are themes where the market may be lagging as a whole – for example, climate change.

As with any tool, users should be aware of its merits and nuances in thinking about how to use it. But to what end? Below, we list some of the use cases that we have identified for different stakeholders.

Getting to work: using the tools

Prioritising engagement and optimising capital allocation

  • Investors can improve the sustainability performance of companies through their funding (rewarding better-performing companies with more capital and increasing the cost of capital for laggards) and their engagement (holding companies accountable, using voting and collaborations with peers). The platform is designed to augment and help align both these channels, providing academic rigour and data-driven insights to support portfolio construction and engagement. Moreover, it can be used internally by companies’ sustainability analysts to identify potentially meaningful areas to focus on.

(For asset owners) Defining and implementing an ESG policy

  • The growing regulatory pressure for asset owners to define their investment beliefs around ESG topics is increasingly moving from qualitative to quantitative – for example, UK requirements for pension fund trustees to monitor, and eventually set targets for, the carbon performance of their investments. Yet asset owners do not always have access to decision-useful information to identify material ESG topics (is the management of carbon emissions by energy companies more important than good governance for IT firms?) or to link the identified topics with the profile of their existing investments.
  • The platform helps asset owners identify ESG topics that have a higher potential to drive shareholder value appreciation. They can also explore the portfolio risk-return implications from maximising ESG impact across a given dimension. For example, an investor can specify an implied temperature rise target and use the tools to calculate an optimal portfolio allocation in terms of the maximum expected return and minimal risk compatible with that temperature.

(For companies) Benchmarking corporate strategies against best practice

  • Amid a proliferation of ESG scorecards, questionnaires and methodologies, companies may struggle to understand which areas of ESG improvement are likely to be most valued by the market. By focusing on a smaller number of material ESG factors, alongside examples of the top-performing peers on each indicator, companies can more easily tackle gaps in their ESG strategies.

(For all stakeholders) Collaborating to raise market standards

  • Existing investor, corporate or NGO initiatives can leverage the research to strengthen their engagements with companies or regulators. By making the data publicly available, the platform aims to drive further collaboration to promote better management of environmental resources, increase gender diversity and well-functioning boards across markets.

We believe the ESG for Investors platform can make a positive, novel contribution to the ESG debate, leveraging academic rigour to help investors achieve real-world impact.

This material is for your information only and is not intended to be used by anyone other than you. It is directed at professional clients and eligible counterparties only and is not intended for retail clients. The information contained herein should not be regarded as an offer to sell or as a solicitation of an offer to buy any financial products, including an interest in a fund, or an official confirmation of any transaction. Any such offer or solicitation will be made to qualified investors only by means of an offering memorandum and related subscription agreement. The material is intended only to facilitate your discussions with Fulcrum Asset Management as to the opportunities available to our clients. The given material is subject to change and, although based upon information which we consider reliable, it is not guaranteed as to accuracy or completeness and it should not be relied upon as such. The material is not intended to be used as a general guide to investing, or as a source of any specific investment recommendations, and makes no implied or express recommendations concerning the manner in which any client’s account should or would be handled, as appropriate investment strategies depend upon client’s investment objectives. Funds managed by Fulcrum Asset Management LLP are in general managed using quantitative models though, where this is the case, Fulcrum Asset Management LLP can and do make discretionary decisions on a frequent basis and reserves the right to do so at any point. Past performance is not a guide to future performance. Future returns are not guaranteed and a loss of principal may occur. Fulcrum Asset Management LLP is authorised and regulated by the Financial Conduct Authority of the United Kingdom (No: 230683) and incorporated as a Limited Liability Partnership in England and Wales (No: OC306401) with its registered office at Marble Arch House, 66 Seymour Street, London, W1H 5BT. Fulcrum Asset Management LP is a wholly owned subsidiary of Fulcrum Asset Management LLP incorporated in the State of Delaware, operating from 350 Park Avenue, 13th Floor New York, NY 10022.
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About the Author

Rahil Ram

Rahil Ram is a Director at Fulcrum Asset Management and is involved in portfolio strategy, portfolio implementation, research, sustainability and idea generation for the discretionary macro and thematic strategies. Prior to joining Fulcrum, Rahil was a strategist within the Asset Allocation team at Legal & General Investment Management for five years, during which time he completed his Masters’ in Actuarial Management from Cass Business School and qualified as an Actuary in 2017.

About the Author

Iancu Daramus

Iancu works on the development of Fulcrum’s responsible investment capabilities. Prior to joining Fulcrum in 2021, Iancu was at Legal & General Investment Management where he led the stewardship team’s work in the energy sector and advised institutional clients on low-carbon investment solutions. Iancu graduated from the London School of Economics and holds degrees in philosophy and public policy.