How can investors and portfolio managers use environmental, social and governance (ESG) data to develop investment strategies to align with a more sustainable approach?
- We explore how ESG data can be used in effective investment strategies.
- ESG data can inform investment strategies by analysing how responsible capital allocation can contribute to restoring the earth.
- Investors can also uniquely construct their portfolios by creating their own ESG scores.
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Investors and portfolio managers are seeking in-depth ESG data and research. We explore ways in which investors can use ESG data to create more sustainable investment strategies.
Structuring investment strategies
Clients and the investment community as a whole are exerting increased pressure on asset managers to structure investments according to environmental metrics. This can be done through specific environmental metrics or via environmentally focused scores.
Recently, Refinitiv partnered with Probability & Partners to research investing against specific sustainability goals – UN Sustainable Development Goals #12 (Ensure more Sustainable Consumption and Production) and #13 (Urgently Combat Climate Change).
The paper, “How can tailored portfolios help achieve sustainability goals?” finds, through multiple portfolio measures, sustainable investors do not necessarily compromise on performance and in some scenarios they can expect an outperformance of their portfolio over the benchmark.
In connection with the metrics used in the SDG research, Refinitiv offers:
- Environmental Pillar Score
- Emissions Score
- Environmental Innovation Score
- Resource Use Score
Like much ESG data over the years, company disclosure has increased, allowing investors to get a broader look at their initial investment universe.
Now we are seeing large numbers of firms being assigned environmental scores, with high average scores across the FTSE All World Index.
Refinitiv creates ESG scores based on ESG magnitude materiality. As the importance of ESG factors differs across industries, we have mapped each metric’s materiality for each industry.
The methodology of the focused environmental scores uses some metrics in the creation of environmental scores for all/near all industries. Disclosure is high on these measures.
- The Emissions Score is calculated based on a variation of 28 metrics, depending on industry. The Policy Emissions metric is used in all industry calculations. As it is deemed material to all industries, 84 percent of companies with an Emissions Score report having an emissions policy.
- The Environmental Innovation Score is calculated based on a variation of 20 metrics, depending on industry. The Environmental Products metric is used in all industry calculations except uranium. It is deemed material to all but one industry, and 60 percent of companies with an Environmental Innovation Score report having at least one product line or service that is designed to have positive effects on the environment or which is environmentally labelled.
- The Resource Use Score is calculated based on a variation of 20 metrics depending on industry. The Policy Energy Efficiency metric is used in all industry calculations except uranium, and is deemed material to all but one industry. Eighty-seven percent of companies with a Resource Use Score report having an energy efficiency policy.
Capital allocation will play a large role in helping economies reach net zero. Have you got access to the metrics you deem material?
An alternative view
ESG metrics give managers another view into their investment strategy. If we take the Emission Scores from the Refinitiv ESG database, we can see improvements in the score across industries and how creating portfolios based on the score can provide further insight.
The scores measure a company’s commitment and effectiveness towards reducing environmental emission in the production and operational processes.
In a simple piece of portfolio analytics, we created portfolios based on Emissions Scores and industry. We looked at:
- The industry that has the highest number of companies assigned an Emissions Score
- The industry with the highest average score
- The industry with the largest improvement over the last four years
We then created two portfolios in each industry:
- Portfolio 1 – includes all companies with Emissions Score of 50-100
- Benchmark – includes all companies with Emissions Score of 0.01-49.99
We found that the Realized Alpha and Sharpe Ratio were better in the portfolios with higher Emissions Scores. Within the financials example, we also found the portfolio outperformed the benchmark and had a better Information Ratio.
Model portfolios versus benchmarks
Approaching investment strategies
ESG data can help you approach investment strategies in a different way by creating your own scores.
We understand that a single ESG score might not represent the focus of a given investment strategy that may be aimed more specifically at a particular theme (or subset), such as addressing the climate crisis or optimising resource usage.
Furthermore, the data points most pertinent to investment decisions may differ based on whether you are utilising them to support risk management, driving the search for alpha generation, or focusing on social or environmental impact. To this end, you need access to ESG data at a granular level.
To help you develop customised ESG scores, Refinitiv provides 500+ standardised ESG data points on over 11,500 companies, which can be categorised by industry and commingled with financial data to enable managers to build their own view of materiality.
Full access to the underlying data enables customisation of company scores to meet a firm’s view on issues such as materiality, momentum, and time weighting.
Customised scores give a robust picture of a company’s sustainability, allowing managers to assess the ESG risks and opportunities of a firm and benchmark against peer companies to make more informed investment decisions.