Georges Archibald
Almost two centuries ago, gold prospectors in California set off one of the greatest rushes for wealth in history. Proponents of socially conscious investing claim fund managers will start a similar stampede when they discover that environmental, social and governance (ESG) insights can yield treasure in the form of alternative data that promise big payoffs — if only they knew how to mine it.
There may be some truth to that line of thinking if you take some of the rhetoric and advertising out of the equation.
First, let’s be clear: ESG is not on the fringe. The European Union has implemented new financial regulations via the Sustainable Finance Disclosure Regulation (SFDR). These improve ESG disclosures and considerations and help to direct capital toward products and companies that benefit people and the planet. As we write, the U.S. Securities and Exchange Commission is also considering drafting and implementation of ESG-related regulations.
Whether enacted or currently under consideration, these rules encourage fund managers to integrate sustainability risks into their business processes, report on them publicly, stamp out greenwashing, and promote transparency and knowledge among investors. Accordingly, it will become easier to compare firms’ sustainability efforts, too, allowing stakeholders from all corners to make more informed decisions.
Incorporating ESG factors into investment strategies is not new, of course. The world’s largest asset managers have been practicing it for years. According to the Governance & Accountability Institute, 90% of companies listed on the S&P 500 now produce sustainability reports, an increase of 70 percentage points from more than a decade ago.
Yet some are still groaning about adopting an ESG investing mindset; they see ESG as a nuisance that detracts from their mission of earning high returns. But could this mindset mean they are missing important opportunities?
Don’t wait
Waiting for new mandatory ESG reporting and compliance framework standards in the U.S. puts Americas-focused managers at a significant disadvantage. Fund managers can start gaining insights today from alternative data originating in ESG-related data stemming from climate change, natural disasters, harassment and discrimination lawsuits, and other events and information that can be mined.
For instance, analysts who scrape auto traffic emissions data to identify demand at shopping malls and store parking lots might have an edge over those waiting for the latest consumer confidence figures. Fund managers who keep an eye on public and private plans to mitigate rising sea levels or electrical grid failures gain insights into coming capital spending. Tracking businesses that report the inside scoop on workplace cultures can predict a company’s growth prospects for the future.
Sources of ESG data are all around us — in newspapers, social media, weather reports, satellite images, academic and nonprofit research, and, increasingly, corporate disclosures. But what’s most important is finding value in the data that others gloss over or ignore.
For example, Neuberger Berman’s chief data scientist, Michael Recce, used employee review website Glassdoor to identify companies ripe for shorting. What is telling is that he wasn’t so interested in information coming from the companies themselves. Self-reported data, after all, rarely contain the whole story. “In the longer term, stock prices ultimately have to reflect the true value of their businesses,” he told MarketWatch. “You have to look at places where the data can’t be spun.”
As he suggests, the key is looking for the longer-term impacts telegraphed in unstructured data, which take the market a while to assimilate because of inefficiencies in processing ESG information. The Cambridge Analytica scandal, which involved violations of data privacy, for instance, took months to affect Facebook’s share price.
Find a data partner
While this raw data is messy and can be difficult to process, new technological advancements increasingly make it easier to examine more types of alternative data to stay ahead of the markets. Even so, the technology has only come so far, and few people have the expertise in crunching the data and performing financial valuations based upon it.
Now is the time to engage partners who can help firms develop that expertise in order to stake a claim in the evolving but critically important ESG paradigm that defines value. In the future, it’s going to be key to marry the expertise of front-office executives with that of fund administrators and service providers who understand where to find ESG gold.
More investors are rightfully demanding ESG investing processes and paradigms be implemented as they are inextricably linked to value — moral, ethical and economic. It is the only alternative.
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