Financial Advisors

The Rise of ESG and the Importance of ESG Data

With the surge of ESG investing, fund managers need ESG data, tools and analytics to aid decision making.

Jason Stevens, EVP, Chief Technology Officer, Ultimus Fund Solutions

Introduction

ESG is a hot topic. That’s not surprising given the sums of money flowing into Environmental, Social and Governance (ESG) strategies. Investments in ESG strategies grew 42% from 2018 to 2020. Today, one of every three dollars of assets under management is invested in ESG strategies. ESG funds are on track for a record year of inflows in 2021 as well, raking in more than $21 billion in the first quarter alone.2

Yet with all the buzz around ESG, we found that many investment managers and advisers could benefit from an explanation of ESG strategies and available ESG resources. With that, Ultimus hosted a webinar with industry panelists Stacy Louizos, John Pileggi, and Vladimir Kaplun to address:

  • What is ESG and the spectrum of ESG strategies
  • The growth of ESG and the recent Risk Alert published by SEC’s Division of Examinations
  • Sources of ESG information
  • Data integration for pre-trade ESG analysis and post-trade ESG compliance

The balance of this article is a summary of the webinar panel discussion. To set the stage, we begin with an explanation of the E, S and G behind the strategy.

ESG Explained

ESG investors consider a company’s record across E, S and G factors — alongside traditional fundamental analysis — when making investment decisions.

Environmental. Examples include the company’s focus on climate change and carbon emissions; energy usage; waste management; and water and land usage.

Social. Examples include relationships between the company and its employees, suppliers, customers and the community; diversity issues; and responsible marketing.

Governance. Examples include a company’s leadership or board structure; executive compensation; and shareholder rights.

ESG table
  1. Morningstar Direct data as of 6/30/20
  2. https://www.cnbc.com/2021/05/09/esg-investing-to-reach-1-trillion-by-2030-head-of-ishares-americas.html

The Spectrum of Environmental, Social and Governance Investing

Our panelists noted an important distinction: ESG investing is a strategy, not an asset class. There are different mandates for ESG strategies and different ways to implement the strategies.

The Range of Investment Strategies, With and Without ESG Criteria

ESG table

Does ESG Equate to a Sacrifice in Fund Performance?

There is a common misperception that focusing on ESG factors means sacrificing performance. As shown in the graphic above, some ESG strategies put profits above or on par with social and environmental impact. Others emphasize impact above profits.

Numerous studies over various time periods have shown that companies that implement ESG into their business model perform better over the longer term1. This has been borne out during the pandemic as funds with ESG strategies outperformed traditional funds2.

Many investors now use ESG criteria as part of their fundamental analysis of investments. This is based on the idea that to understand the opportunities and risks of a company, it’s necessary to take ESG criteria into account.

Interest in ESG has Skyrocketed

In 2020, net inflows into ESG funds in the U.S. reached $51.1 billion, a significant increase over 2019 when flows equaled $21.4, which itself was a record.3 Global ESG investing by end of the first quarter in 2021 was nearly $2 trillion4.

Assorted factors are driving the popularity of ESG strategies:

  • Negative cost and risk of not implementing
  • Reputational risk
  • Customer expectations
  • Investors
  • Employees
  • Supply chain, rating agencies, banks, insurance companies and more

Women, millennials and high-net-worth individuals represent demographic segments playing a role in this trend.

1https://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/five-ways-that-esg-creates-value#

2https://www.morningstar.com/articles/1017056/sustainable-equity-funds-outperform-traditional-peers-in-2020

https://www.morningstar.com/articles/1019195/a-broken-record-flows-for-us-sustainable-funds-again-reach-new-heights

4https://www.cnbc.com/2021/04/30/theres-no-hotter-area-on-wall-street-than-esg-with-sustainability-focused-funds-nearing-2-trillion.html

The SEC’s Division of Examinations has Noticed

The SEC has placed ESG strategies high on its exam priorities list. In April 2021, the Division of Examinations issued a Risk Alert to highlight observations from recent exams of entities offering ESG products and services. Notably, ESG strategies are defined in the broadest sense, to include socially responsible and impact investing.

A few takeaways for asset managers:

Ensure clarity and consistency. The ESG strategy must be consistently and accurately disclosed across all materials available to the public, including regulatory filings, policies, marketing materials, websites, published studies, etc.

Do what you say you’re doing. Actual investments and practices must reflect the disclosed ESG strategies and processes.

Integrate compliance. Compliance oversight of ESG practices should be performed by those knowledgeable of and familiar with the firm’s ESG policies and procedures.

Sources of ESG Information

As an investor, where can you find reliable ESG information? What are the standards to abide by? How do you access ESG data broadly and for individual companies?

Our panelists mentioned a few helpful resources, including:

Data Resources for Pre-Trade ESG Data Analysis and Post-Trade ESG Compliance.

Standardizing, capturing and consolidating ESG data across companies is a vast undertaking. But this is necessary to compare ESG factors across companies and sectors – and to develop a ranking system. Data is commonly sourced from the companies directly or from publicly available third-party resources. Some vendors even offer their tools to corporations to confirm the accuracy of the data tracked. Reliable data is key to be able to perform proper analysis. Identifying and performing due diligence on the data source will ensure consistent and dependable data for proper analysis.

Our panelists noted that quality, granular and timely ESG data resources are needed for (at least) two distinct purposes: pre-trade ESG data analysis and post-trade ESG compliance. The pre-trade analysis has become an integral part of opportunity and risk assessments. But access to ESG data is also crucial for compliance purposes to assess adherence to the documented ESG strategy. There are industry tools and resources available for both pre- and post-trade analysis.

For pre-trade data analysis, the webinar featured ICE Data Services as one service provider option which has a range of ESG data and tools to help gain transparency and manage risk. And, for post-trade compliance, Ultimus’ proprietary uCOMPLY application is designed to helps fund managers monitor investment portfolios against fund guidelines with a high degree of accuracy while providing flexibility and highly customizable reporting that managers need. Since uCOMPLY is proprietary to Ultimus, it offers a level of flexibility to clients not available in third-party compliance monitoring programs, as well as flexibility in building additional features in response to client needs and the changing regulatory environment.

The Role of the Administrator. Champions of Data and Compliance.

Knowing the importance of “doing what you say you’re going to do” when it comes to ESG, you may want to engage your Fund Administrator to assist with oversight of your ESG strategy and implementation. Ultimus is a provider of full-service fund administration, accounting and investor solutions to help launch and administer products that include ESG strategies. Ultimus also can assist with post-trade compliance through our uCOMPLY application as mentioned previously, helping to keep funds within their preset ESG guidelines. For more information, please contact inquiry@ultimusfundsolutions.com.

A special thanks to our webinar panelists:

  • Stacy Louizos, Partner, Co-Chair of Investment Management Group & Co-Leader of ESG Team, Blank Rome LLP
  • Vladimir Kaplun, Director, Business Development & Strategy, North America, ICE Data Services
  • John Pileggi, Chief Investment Officer, Uncommon Giving Corporation

Investing primarily in investments that meet ESG criteria carries the risk that a fund/strategy may forego otherwise attractive investment opportunities or increase or decrease its exposure to certain types of issues and, therefore, may underperform funds that do not consider ESG factors.

Originally published on Ultimus Fund Solutions.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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Ultimus Fund Solutions

Ultimus Fund Solutions (Ultimus) is a trusted business partner to asset managers, delivering customized Fund Administration solutions. The company is leading provider of full-service fund administration, accounting, and investor solutions to support the launching and servicing of registered funds, private funds, and public plans. Ultimus also offers customized structures designed for the unique needs of pensions, endowments, foundations, and other large institutions.

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