ESG – what is it good for?
In recent years, ESG has been commonly used for risk screening and compliance purposes. Some investors have found ESG integration useful for identifying companies with long term sustainability potential, or finding a strong correlation between ESG performance and financial results. On the latter, many practitioners have found this relationship to be inconsistent, varying across market cap, sectors and investment horizons.
Ultimately, many investment managers question the link between ESG performance and company earnings. To compound the issue, at Neudata we have noticed that ESG research agencies often find conflicting results in their analysis.
So why are there discrepancies? And will finding the cause of polarised research outcomes provide us with a more accurate picture of what ESG is good for?
ESG data providers often use different data sources…
Perhaps one obvious explanation lies in the different data sources each ESG research agency uses. This would, unsurprisingly, lead to different sustainability ratings for the same company and produce inconsistent results in any financial analysis. For example, some research agencies primarily base their ESG ratings on self-reported company information (e.g. carbon emissions), while others use a mix of publicly available sources, third party information, NGO datasets and information from news articles. Other ratings providers also use ‘alternative’ ESG data sources, such as brand reputation information scraped from social media sites or crowdsourced employee satisfaction levels, collected from websites like Glassdoor.
Neudata view: To produce an objective and accurate ESG signal, information cannot primarily be based on self-reported corporate narratives, especially if the information is voluntary and not subject to regulatory oversight1. As such, ESG research agencies primarily using self-reported company data is of lower value than data derived from a mix of alternative data sources and self-reported information. Corporate disclosures suffer from information bias as companies are likely to only disclose information that paints them in a positive light – alternative data can therefore provide a solution by capturing data points that companies avoid publicly sharing.
…as well as different ratings methodologies
The differences in ratings methodologies used by a wide variety of ESG research agencies can provide another explanation for conflicting research outcomes.