An ESG Data Framework for Empowering Sustainable Investment Strategies

In today’s shifting investment landscape, ESG is no longer an option. Sustainability factors have become significantly important for investors and fund managers. The magnitude of ESG in investment decisions is evident from the surge of capital allocations driving sustainable investments. A new ESG report from Bloomberg shows that global ESG AUM is on track to surpass $40 trillion by 2030.¹ With such an influx of capital inflow, ESG’s days as a fleeting trend are gone. Sustainability is now a permanent fixture occupying space in almost every institutional portfolio. Along with the increasing allocations owing to the rising demand from investors comes the necessity of transparency. Investors want to know and see how their cash is contributing to the greater good.

As investors and fund managers place greater emphasis on sustainable and responsible investing, the need for reliable and comprehensive ESG data is imperative. In turn, the role of ESG data providers is pivotal in supporting fund managers throughout the investment process, from initial portfolio construction to ongoing monitoring and sustainability performance reporting. A lack of reliable and actionable ESG data prohibits firms from embarking on and succeeding through sustainable investment strategies.

ESG data struggles

Fund managers encounter several challenges when it comes to obtaining reliable ESG data. Availability and coverage can vary significantly across different sectors, regions, and company sizes. Smaller and private companies often have limited ESG data available, making it difficult to get a comprehensive view, while emerging markets are likely to have less developed ESG disclosure practices, leading to data gaps.

ESG data quality concerns

Quality is another area of concern. Inconsistencies across ESG data are inherently common, with different data providers using varying methodologies, definitions, and metrics. A proliferation of ESG regulatory reporting frameworks aims to deliver transparency and consistency for investors. However, a lack of standardized reporting frameworks makes it tricky to compare ESG performance across companies and industries. Furthermore, ESG data may contain errors, or biases, requiring extensive data cleansing and validation.

ESG data is often published with a significant time lag, making it less relevant for timely investment decisions. In addition, the frequency of ESG data updates can vary, with some metrics only reported annually or biannually. Determining which ESG factors are most material to a specific industry or company can be complex and subjective, and so fund managers must carefully evaluate the relevance and significance of ESG data to their investment strategies and goals.

Data to comply with multiple regulatory requirements

Evolving regulatory frameworks, such as the EU Sustainable Finance Disclosure Regulation (SFDR), are solidifying the need for more detailed and standardized ESG reporting. Fund managers need to navigate these changing requirements and ensure their data and disclosures are compliant. Obtaining, processing, and analyzing ESG data can be resource-intensive, requiring specialized expertise and technology infrastructure. Smaller investment firms may face challenges in allocating sufficient resources to ESG data management and integration.

To address these challenges investment firms are increasingly collaborating with ESG data providers to overcome data obstacles. With harmonized ESG data from a specialized ESG data provider, fund managers can more effectively incorporate ESG considerations into their investment decision-making and demonstrate the sustainability performance of their portfolios to clients and stakeholders.

ESG data in the investment process

ESG data providers often offer guidance alongside their data solutions to help firms meet their sustainability investment objectives and regulatory obligations. Investment firms can leverage ESG data from these providers to:

• Develop sustainable investment strategies by identifying material ESG risks and opportunities
• Incorporate ESG factors into their investment analysis, portfolio construction, and risk management processes
• Measure and report on the ESG performance of their portfolios, both to internal and external stakeholders
• Comply with regulatory requirements and demonstrate their commitment to sustainable investing

Portfolio construction and sustainable investment strategies

ESG data providers collect, aggregate, and analyze vast amounts of information on companies’ environmental impact, social practices, and corporate governance. When fund managers are building portfolios aligned with ESG principles and investor preferences, this type of ESG data is invaluable. By incorporating this information into their investment strategies, fund managers can identify companies that are leading in sustainability ratings, as well as those that may pose greater environmental or social risks.

Access to comprehensive ESG data enables fund managers to identify leaders and laggards and make more informed asset allocation decisions. By integrating multi-dimensional ESG risk scores with valuation models, and using historical data for back testing, they can construct portfolios that meet required ESG criteria, and potentially generate better long-term returns.

ESG portfolio monitoring and management

Ongoing monitoring is essential to ensure investments continue to meet ESG standards over time. ESG data vendors provide real-time updates on factors such as carbon emissions, workforce diversity, board composition, and controversies involving portfolio companies. ESG risk ratings allow portfolio-level manager evaluation across asset classes. Actively managing portfolios allows for adjusting swiftly as needed to maintain alignment with clients’ ESG goals. Additionally, emerging ESG-related risks and opportunities are more quickly identifiable.

Sustainability performance reporting

Investors are increasingly demanding transparency and accountability when it comes to the sustainability performance of their investments. ESG data providers play a crucial role in helping fund managers meet these reporting requirements. By leveraging the holistic data delivered by ESG data providers, fund managers can generate detailed reports that showcase the ESG characteristics of their portfolios, track progress towards sustainability targets, and demonstrate the tangible impact of their investments. This level of reporting is invaluable in building trust and credibility with clients, as well as meeting regulatory and industry standards.

A framework for evaluating ESG data providers

Developing a comprehensive framework to consider several dimensions and key components to assess ESG data providers. The following framework can be used to help fund managers and investment firms and is amended to fit their specific needs and use cases.

1. Data quality and reliability

a. Accuracy and consistency:

i. Are the ESG scores and metrics accurate and consistent across different companies and sectors?

ii. Are there any known biases?

b. Frequency of updates:

i. How frequently is the data updated?

ii. What is your firm’s desired frequency or requirements for receiving regular updates (quarterly, annually)?

c. Data verification and audit:

i. Does the provider have robust processes for verifying and auditing the data they collect?

ii. How is the data governed? Are third-party audits conducted?

2. Data coverage and scope

a. Geographic coverage:

i. What is the geographic reach of the data?

ii. Does it cover all markets where your portfolio is invested?

b. Sector and industry coverage:

i. Are key industries and sectors for your portfolio adequately covered by the data provider?

c. Depth of data:

i. Is the granularity of data provided sufficient (e.g., company-level data vs. aggregated scores, qualitative vs. quantitative data)?

3. Methodology and transparency

a. Scoring and rating methodologies:

i. Which methodologies are used to calculate ESG scores and ratings?

ii. Are the methodologies transparent and aligned with industry standards (e.g., SASB, GRI, TCFD)?

b. Materiality framework:

i. Does the provider use a materiality framework that aligns with your investment strategy?

ii. Do they emphasize issues that are financially material to specific sectors?

c. Weighting and normalization:

i. Are there clear explanations on how different ESG factors are weighted and normalized across companies and sectors?

4. Data integration

a. Data accessibility:

i. Which formats available (APIs, Excel, dashboards, etc.) and the ease of integration with existing investment management systems

ii. How easily can the data be accessed?

5. Alignment with investment strategies

a. Customization:

i. Can the data and ratings be customized to align with specific investment objectives or strategies (e.g., thematic investing, impact investing, or exclusionary screening)?

b. Regulatory compliance:

i. Does the data provider comply with relevant regulatory requirements and standards (e.g., EU SFDR, SEC rules)?

c. Forward-looking metrics:

i. Does the provider offer forward-looking metrics such as scenario analysis, transition risk assessments, and climate risk exposure?

ii. Do they have a roadmap for adding new data elements or consideration of future trends?

6. Cost and value

a. Pricing and license structure:

i. How is pricing and licensing structured? Are they subscription-based, per user, per data point?

ii.  What are the license fee terms?

b. Value for money:

i. Does the provider offer unique insights or data that justify the cost?

ii. What is the expected return on investment?

7. Reputation and market presence

a. Market perception:

i. What is the provider’s reputation in the industry?

ii. Are they recognized leaders in ESG data, based on reviews, testimonials, and case studies?

b. Client base and track record:

i. Who comprises the data provider’s client base and track record?

ii. Are they widely used by other fund managers and investment firms?

8. Sustainability performance reporting

a. Reporting capabilities:

i. Does the provider offer tools and templates to support sustainability reporting and disclosure requirements (e.g., impact reports or carbon footprint analysis)?

b. Data completeness for reporting:

i. Is the data comprehensive enough to support mandatory and voluntary sustainability performance reporting frameworks?

ESG data providers for investing

The availability and quality of ESG data continues to evolve at a rapid pace. Staying abreast of the latest developments enables fund managers to effectively incorporate ESG considerations into their investment strategies and portfolio management. With comprehensive, granular and multi-dimensional ESG data, fund managers can optimize investment analysis and reinforce investment decisions for stakeholders by highlighting risks and opportunities based on material ESG information. Real-time data integration enables a real-time view on leaders and laggards, facilitates portfolio screening with multiple scores and weightings, and provides dynamic insights into company-level sustainability performance.

Here is a summary of some well-known ESG data providers in the investment space:

MSCI

• MSCI is one of the largest and most established ESG data providers, offering comprehensive ESG ratings, research, and analytics for thousands of companies worldwide.
• Widely used by institutional investors for portfolio screening, optimization, and reporting.
• Ratings methodologies and models include individual company ESG ratings, ESG fund ratings for mutual funds and ETFs, and ESG and climate metrics for indexes.

ESG Book

• ESG Book is an emerging ESG data vendor that has been gaining traction in the investment management industry.
• Enables company and portfolio level analysis with ESG data for more than 25,000 companies.
• Performance scores are a transparent, data-driven assessment of corporate sustainability performance inspired by SASB’s materiality framework

Morningstar Sustainalytics

• Morningstar Sustainalytics is a leading provider of ESG and corporate governance research, ratings, and analytics
• Renowned for its in-depth company-level ESG assessments and thematic research

S&P Trucost

• S&P Trucost delivers expertise in environmental data and carbon footprint analysis
• Provides detailed metrics on greenhouse gas emissions, energy usage, water consumption, and more
• Supports climate-related risk and opportunity assessments for investment portfolios

Bloomberg

• Bloomberg ESG is integrated within the Bloomberg Terminal and provides a comprehensive suite of ESG data and analytical tools.
• Enables firms to assess the ESG performance of companies and build custom ESG-based portfolios.

When selecting ESG data providers, investment firms should consider factors such as data coverage, quality, analytical capabilities, integration with existing systems, and alignment with their specific investment strategies and sustainability goals. Integrating multiple complementary data sources can provide a more comprehensive and robust view of ESG performance and risks.

Ultimately, the choice of ESG data providers will depend on the investment firm's unique needs, resources, and the evolving landscape of ESG data and analytics in the financial industry.

Conclusion

As the importance of sustainable investing continues to grow, the role of the ESG data provider has become indispensable for fund managers. Enhanced ESG transparency and access to more reliable and comprehensive ESG data better supports their investment strategies and sustainability goals.

By delivering the data, analytics, and reporting tools necessary to integrate ESG considerations into investment strategies, these providers are enabling fund managers to better serve their clients, mitigate risks, and contribute to a more sustainable future.

Sources:

1. ESG AUM set to top $40 trillion by 2030, Bloomberg, February 2024