ESG stays on trend despite data minefield

Affluent clients of wealth managers are increasingly demanding that their money be aligned with their values, pushing their advisers to make investments in tune with their environmental, social and governance (ESG) concerns.

But while asking a wealth manager to build a sustainable investment portfolio is relatively simple, measuring the social and environmental impact of that portfolio is a far more complex proposition.

Part of the problem is what many call ESG’s “alphabet soup”. A plethora of acronyms has sprung up representing different standards and organisations that have emerged in the sector, each with its own framework and metrics designed to measure everything from a company’s carbon footprint to its progress on corporate diversity.

The Global Reporting Initiative (GRI), for instance, launched its sustainability-focused reporting guidance in the late 1990s. Others include the CDP (formerly the Carbon Disclosure Project), the Sustainability Accounting Standards Board (SASB) and the Task Force on Climate-related Financial Disclosures (TCFD).

These and other frameworks cater to a wide range of users, from investors, asset owners, portfolio managers and fiduciaries to regulators. “There are huge issues with the data,” says Oliver Gregson, head of the UK and Ireland markets for JPMorgan Private Bank. “There’s a very wide range of constituents looking for information to answer the question, ‘how is it going?’”

For most individual investors, however, answering this question is not prompting them to scrutinise ESG scores or sustainability standards and frameworks. “It’s a handful that want the detail,” says Leslie Gent, head of responsible investing at Coutts, the private bank.

And the absence of simple, standardised metrics does not seem to be deterring private investors from engaging in sustainable investing, says Eva Lindholm, head of the UK & Jersey wealth management business at UBS.

This is particularly true for a client base made up of more women and younger people. In Capgemini’s 2020 World Wealth Report, 27 per cent of wealthy individuals expressed an interest in sustainable investing, a figure that rose to 49 per cent among ultra-high net worth individuals under the age of 40.

“They understand that a perfect algorithm for measuring all the things they want to measure doesn’t exist yet,” she says. “But they want to align their investments with their values anyway,” says Lindholm.

When they do seek evidence of the impact their investments are making, private clients often look for information they can easily comprehend.

James Purcell, group head of sustainable investing at Luxembourg-based Quintet Private Bank, cites examples such as carbon emissions measured in terms of flight equivalents or water consumption seen in terms of numbers of showers or swimming pools. “What they tend to seek are metrics that are more understandable and relatable,” he says.

However, this does not give wealth managers licence to ignore ESG measurement and reporting — far from it. “If someone asks, you need to show it to them,” says Gent.

Moreover, while they may not be demanding detailed reporting or ESG scoring on their investments, private clients still want to know that their wealth managers are taking account of these metrics and scores in building sustainable portfolios.

This means wealth managers need to do the legwork in the background as they build their clients’ portfolios. “The decisions that we make on behalf of a client when we’re acting in a sustainable manner need to be absolutely credible,” says Purcell. “But do you then spend 30 pages discussing it with the client? Probably not.”

However, even for wealth managers who are well versed in the metrics, navigating this ever-evolving landscape is not easy.

“Staying on top of the next new framework [requires] a considerable amount of work,” says Gent. “It’s understanding the data, what is relevant and material and what is the methodology behind it – you need to do your homework.”

The Financial Conduct Authority, the UK regulator, this week announced plans for new climate risk reporting requirements for asset and wealth managers, giving investors comparable and consistent information. But in the absence of broader harmonised standards and frameworks, investment decisions remain heavily dependent on a more traditional approach: hands-on engagement.

This is the case at London-based Stanhope Capital, which has developed a four-tier sustainability scoring system based on a combination of data from Sustainalytics, an ESG ratings provider, and engagement with fund managers.

Jonathan Bell, Stanhope’s chief investment officer, says: “The Sustainalytics data ranks highly but the focus is on the engagement with managers.”

Gregson agrees. He argues that the data alone is currently insufficient as a basis on which to build a sustainable investment portfolio. “There are no off-the-shelf solutions that cater to a wide range of client needs,” he says.

This means firms must develop their own ability to make ESG-based assessments of potential investments.

“We’re investing a huge amount of effort in building an internal proprietary reporting capability that looks [beyond] what a company discloses,” says Gregson. “Because that’s typically out of date and not decision-grade ready for us as a fiduciary or for our clients.”

This may be about to change. In November, at the UN’s COP26 climate summit, the International Financial Reporting Standards Foundation — which develops and promotes international accounting standards — is set to launch a global Sustainability Standards Board.

If governments adopt the standard, as experts believe many will, ESG measurement and reporting could become more streamlined and easier to execute.

In the process, the assessment task for wealth managers may shift from a heavy reliance on hands-on engagement to a greater use of data, says Lindholm. “That is absolutely what will happen,” she says. “If for no other reason than that it’s a lot quicker.”