Demand has more seeing inclusion of ESG metrics

This could be the year that measuring ESG investing grows up, thanks in large part to investor demand.

"The industry has definitely come a long way over the past decade to really measure ESG," said Michele Giuditta, director of institutional and lead ESG analyst for Cerulli Associates in Boston.

"Asset managers are using data sets that provide metrics and scores. We are seeing a growing number of institutional investors requesting integration" of those metrics with performance, she added.

Cerulli found that 79% of asset managers polled are offering some type of ESG reporting to asset-owner clients, with the most common metric being net carbon footprint. Many of the most widely used metrics are tied to the 17 United Nations-backed Sustainable Development Goals, which are now a decade away from their 2030 target date.

"You are seeing a lot of pension plans and other institutions talking about how they're putting this into place. The nice thing is, a lot is available for free," Ms. Giuditta said.

"A lot is very time-consuming. In many cases, they are picking one or two methods," she said, or teaming up with non-profit organizations or consultants to help with data analysis. Additionally, asset managers report using multiple data sets or raw data to build their own data points most relevant to their clients' interests, she noted.

A lot also depends on how companies disclose their ESG-related activity or risks. A 2020 proxy season preview released by the EY Center for Board Matters found that for investors trying to assess how companies are managing environmental and social risk and opportunities, 85% cited a lack of standardization and perceived gaps in company reporting.

That is expected to change with growing adoption of 77 industry-specific sustainability accounting standards published in November 2018 by the Sustainability Accounting Standards Board. The standards and a "Materiality Map" are aimed at helping companies identify and communicate performance on the sustainability issues most relevant to financial performance. SASB CEO Janine Guillot credits the organization's investor advisory group, with 44 member organizations and a collective $33 trillion in assets under management, for much of the momentum. Since the SASB standards were codified, more than 100 companies in 15 countries are using them to communicate with investors.

As head of global sustainable research and data for BlackRock Inc. in New York, Andre Bertolotti looks at sustainable investing with a broad mandate, as well as with an investor's point of view. "It starts with the thematic convictions important to investors and then we follow up with metrics," he said.

For both BlackRock and its clients, "the term we use often is materiality," whether it is equities, fixed income or real assets. The firm has 15 different teams involved, "and we are expanding continuously on those (metrics) that define materiality" to understand what companies are doing, he said.

On environmental issues, that could mean looking at an energy company's exposure to greenhouse gases, or how it is managing for energy efficiency or sourcing, as well as supply chain exposure. On social issues, one measure is for how a company deals with external stakeholders through customer or community relations, and another is for internal management of employees, workers' rights or talent management.

"These are things that we believe make companies more competitive; we are not targeting an outcome here," he said. Governance metrics include issues like board quality, independence and effectiveness, and corporate culture.

"Once we have this view of a company, we try to measure" using key performance indicators that are a "very fast-growing business. The amount of data available is quite encouraging. Quality is still an issue. We are trying to navigate those differences among providers and get closer to something like accounting measures. I think we are headed that way," he said.

"Increasingly we are interested in developing our own insights and leveraging our asset teams for measurements. … We have a lot of initiatives obtaining very, very raw data and then we would develop our own signal," said Mr. Bertolotti, who said he also is encouraged by the growing role of big data and cloud computing, including computers that read and understand news or the availability of spatial information like climate data.

"That's great for investors because we are collecting data that's not published by companies. That's been a terrific component," he said.

Nothing beats doing the homework, asset owners say.

"It's about disclosure," said Brian Rice, a portfolio manager for the sustainable investment and stewardship strategies unit of the $254.1 billion California State Teachers' Retirement System, West Sacramento. The unit, with 16 staff members and $5.4 billion under management, makes use of ESG data providers like MSCI ESG Research LLC and Sustainalytics, "but we don't rely on that. There's the data and then there's the interpretation of the data. To me, what is most important is to hear what a company is saying. You can usually tell what companies are doing through what they disclose," he said.

That goes for watching out for greenwashing by managers, as well. "It's about taking time and doing the diligence," Mr. Rice said. CalSTRS is big enough to have its own 25 risk factors for ESG-focused external managers. They also meet with them every quarter for conversations, and many of them are starting to provide their own metrics. "We make it pretty clear to them what our expectations are," Mr. Rice said.

For institutional investors with less clout than CalSTRS or the $225.9 billion New York State Common Retirement Fund, Albany, with its $20 billion commitment to a sustainable investments and climate solutions program, Mr. Rice advises them to "leverage others' expertise. We are involved in a lot of coalitions. Probably the best approach is collaboration," with groups like Ceres, Principles for Responsible Investment and the Investor Group on Climate Change, all of which interact regularly with companies and track how proxies are voted.

Wespath Benefits and Investments, an agency of the United Methodist Church, Glenview, Ill., with $24.8 billion in assets, includes ESG in all RFPs and sends an annual questionnaire to all managers. It also has its own peer scoring system for managers.

"We are also asking for examples of decisions they made where ESG was a factor," CIO Dave Zellner said. "When they come to our offices, we'll ask some pretty pointed questions, as well."

Wespath officials consider addressing climate change within their fiduciary duty, and they are adding more questions and having more conversations with managers, he said. "Going forward, we can see that expanding out into other issues, like urbanization, natural resources stress and demographic changes."

Since it is "a bit of a moving target," Wespath impact investment manager Juan Lois said, "we also have to have a granular understanding at the strategy level. Not just downside risk mitigation, but we also believe there are real opportunities here. … I think the reporting has improved over time."

While companies with a large footprint in Europe have made "clear progress, in the U.S., we are in early days," Mr. Zellner said.

European clients are asking for more ESG metrics, particularly about carbon footprints, while U.S. investors tend to focus on proxy voting, said Melanie Adams, vice president and head of corporate governance and responsible investment for RBC Global Asset Management in Toronto. In the U.S., "we are not getting specific requests for climate-related metrics yet, but I expect that. The data is evolving and improving," although at times it can be too much, so asset owners and managers have to figure out what they really need, she said.

Megan Wallingford, manager of sustainable products research for Sustainalytics in Toronto, said that asset owners with specific interests like climate change are focused on measuring outcomes of corporate ESG-related activity.

"A client comes with a goal and asks for help how to measure. Sometimes it's a theme, like clean water, health or gender diversity," she said. "Some come with an established view on what's going on, others are looking for guidance."

"At the end of the day the right metric really does depend on the goal or theme each client has," Ms. Wallingford said.

Rakhi Kumar, a senior managing director with State Street Global Advisors in Boston, said her firm, which launched its own ESG analysis method in 2019, uses multiple data providers "to screen out the noise" and focus on two or three dozen metrics by industry.

"It's going to be more of a market-led initiative globally. We are really pushing for standardization and we are really relying on SASB to set the floor. ... We are already seeing company disclosure improve."