Back‘Understanding a company’s ESG risk profile can help against downside risks’
Globally, we are seeing more regulation regarding ESG investing for instance requiring investment managers to disclose how they're integrating ESG into their investment processes, says Jaspreet Duhra
Premium Globally, there is a spotlight on Environmental, Social, and Governance (ESG) as more and more investors are now considering sustainable issues to help manage investment risks. The theme was initially driven by institutional investors but is gaining traction amongst retail investors too. Jaspreet Duhra, managing director and global head of ESG Indices at S&P Dow Jones Indices (S&P DJI) talked to Mint on how covid-19 impacted ESG investing, lack of standard ESG definition and the role of indexing in ESG investing.
Edited excerpts:
Why ESG is taking over global investment strategies. What are the drivers and why is it so important?
More investors are looking to incorporate ESG into their investment portfolio. There is a multitude of reasons for this. ESG data provides a more holistic view of the company. This has been aided over the years by increasingly consistent, verified data being released from companies.
There have been numerous studies that show on balance over the long-term companies managing their ESG risks and opportunities well, are more likely to outperform. Understanding a company’s ESG risk profile can also help protect against downside risks.
Globally we are seeing more regulation regarding ESG investing for instance requiring investment managers to disclose how they're integrating ESG into their investment processes.
Some investors will have their holdings scrutinized and if there are problematic companies from an ESG perspective they are open to reputational issues and potentially negative press. Of course – there is a valuable reason for incorporating ESG issues – some investors simply don’t want to hold companies that for instance employ child labor or produce controversial weapons.
How has covid-19 impacted ESG investing?
The increased interest that we're seeing in ESG investing has been sustained during the pandemic and the related market turbulence. In fact, we've seen that this has been an opportunity for ESG to shine a light on some perhaps under-reported issues. So, we saw more questions being asked of companies, particularly around social issues.
How difficult is it to collect ESG data on companies in a country like India, which is still in the process of enacting regulations for ESG disclosures?
In the twenty years, we have been using ESG data in our indices, we have seen a notable uptick in disclosure from companies. In part, it’s due to regulation; In part, it’s due to investors and data providers like S&P Global asking companies questions pertaining to ESG metrics.
Despite this, there are still notable data gaps. The more data we have, the better the ESG analysis we can use in our indices. However, ideally, this data should be consistent, comparable, verified, etc.
S&P Global ESG scores form the foundation for the ESG scores we use in our indices. As part of the data collection process, S&P Global is looking at information in the public domain, but it also considers information submitted from companies in response to questionnaires, enabling S&P Global to form a richer understanding of the companies’ ESG profiles. In turn, this can potentially lead to better public disclosures as companies may begin to report on ESG issues if they see these issues attracting investor interest.
We also have ways to tackle data gap challenges. For instance, we use S&P Global Trucost data for climate metrics. Trucost has developed modeling techniques to fill in gaps where data from companies may be lacking when it comes to metrics like carbon footprints.
There is still no standard definition of what qualifies for ESG. In this context, does ESG investing make sense?
There are plenty of grey areas when it comes to ESG and sustainability. There are of course some topics that are less subjective—such as governance and health and safety. Counting women on the board or the number of accidents should be straightforward. But even in seemingly straightforward areas, there is subjectivity. For example, what percentage of the board should be women? Should this percentage be reflective of the workforce or the broader population? What is a poor accident rate? Are sick days from work-related stress accounted for? Once you start looking at the details, it is easy to understand why ESG scoring providers end up with different assessments. However, there may be some straightforward metrics that all companies should be able to disclose on and there are initiatives in progress to encourage consistent disclosure. For instance, the International Financial Reporting Foundation is working to develop a unified framework of consistent comparable company sustainability disclosure requirements.
What is the reason that fossil fuel, mining and tobacco companies feature in certain ESG funds?
Some responsible investors choose to stay invested in companies involved in those activities. For instance, they are universal asset owners and divestment is not an option. Some investors may choose to implement their responsible investment strategies in other ways – such as shifting the weight towards more ESG orientated companies within industry groups or utilizing other stewardships tools available to them such as voting and engagement. For investors who choose not to hold problematic companies from their sustainability perspective, there will be indices designed with that objective in mind.
We keep hearing buzz words like net-zero, climate change, carbon footprint. What does this mean for an investor interested in ESG and how can one access specific aspects of ESG?
If we take the example of climate indices it depends on the end objective of the user. For those investors who have chosen the path of divestment fossil fuel-free indices would be appropriate.
For those investors who don’t want to divest but want to lower their carbon footprint, we have a carbon-efficient index series. These indices focus on the carbon efficiency of companies relative to their industry peers and the GHG disclosure status of companies – so different climate factors compared to a divestment index. This index is a good option for universal asset owners who are looking for an engagement tool.
Clients are now looking to start their portfolios into net-zero aligned strategies, and we have developed Paris-Aligned and Climate Transition indices. The indices are based on the latest climate science with the rate of annual decarbonization in line with, or beyond, the decarbonization trajectory from the IPCC’s (Intergovernmental Panel on CC) 1.5°C scenario.
How can indexing help dial-up or down exposure to ESG depending on investor appetite and without necessarily having to sacrifice returns?
We understand that investors have different appetites and objectives when it comes to ESG.
Some investors are looking for core benchmarks with an ESG overlay that seek to maintain a low tracking error vs. the parent index. Other investors may be willing to accept potentially higher tracking errors but want to see heightened attention to ESG considerations.
As a benchmark provider, we are transparent about the way we construct indices; all methodologies are published on our website and a range of supporting content is produced discussing the methodologies of key ESG data inputs.
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