While ESG investing has been rising in popularity, industry professionals note that getting investors to put assets in ESG and SRI remains a challenge. While that’s the most obvious hurdle, there are other concerns that hinder the continuing emergence of responsible investment.
Christopher Merker, adjunct professor of finance at Marquette University and executive director of Fund Governance Analytics, noted in a CFA Institute blog post that standards and terminology remain a severe problem. As an example, he cited the A rating — a comparatively high score — that MSCI granted to oil giant ConocoPhillips. Because of that, it’s been included in the ESG funds of two of the world’s largest asset managers, despite the obvious misgivings green-minded investors would have.
Another problem is the lack of consistency among ESG ratings firms. Because of differences in data collection, analysis, and reporting, a given company can get varying scores, depending on the ratings provider. That undermines the assertion of better risk-adjusted performance associated with ESG. “How ESG expresses values needs to be better understood, and the gray area made less gray in relation to SRI principles,” he said. “Are we investing for better performance, impact, or both?”
On the issuer side, Merker pointed out that the disclosures and data provided by issuers need to be better and more insightful. Because too much of the available ESG information is of poor quality, he suggests, efforts to evaluate companies for ESG are muddled.
“[I]nformation overload is a Big Data problem that requires better quantitative methods,” he said. Pointing to work that he’s engaged in at Marquette, Merker described how 17 variables related to governance were boiled down to a single index that was predictive and significant over 12 months and across multiple financial variables and impact measures.
“An investment manager, client, or investment board looking at a report may only be interested in a single index measure,” he said.
Merker also pointed out that the US equity market has been shrinking, while new issuances in the private markets have eclipsed those in the public markets for the last six consecutive years. That implies an imperative for current and future ESG work to be adapted to the private markets.
“ESG has a natural home in the public markets, which already have ongoing disclosure requirements,” he said. “Unfortunately, these requirements are why many companies no longer want to remain public.”
He also pointed out that bond-issuing governments need to be held to the same ESG standards as public companies, particularly given the rapid growth in green bonds and the emergence of social impact bonds (SIBs), among other trends.
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