ESG 2.0: Crowdsourcing Standards and Mass Customization

“More transparency, flexibility, and responsiveness to investor needs will yield tremendous gains in advancing ESG standards in a post-pandemic world.”

With net flows into sustainable funds nearly quadrupling in 2019, attracting a record $20.6 billion, last year was widely heralded as a breakthrough year for Environmental, Social, and Governance (ESG) investing. The dramatic growth provided yet more proof of the heightened demand for ESG investment options from institutional and retail investors alike. With the outbreak of the COVID-19 pandemic, ESG focused funds now face their first real test since entering the mainstream.

The initial signs remain encouraging: assets under management continued to grow in Q1 2020 and, relatively speaking, there is some evidence that ESG funds performed better than broader market indices. There are still a number of underlying challenges to be overcome, however, and the fallout from the pandemic could prove to be an inflection point for ESG investing.

One of the key issues with ESG investing is that it is – by definition – a broad range, encompassing a huge number of factors, even within each of the over-arching environmental, social, and governance themes. As such, ESG can often mean different things to different people. In Europe, for example, ESG is typically viewed through more of an environmental lens with climate change and carbon risk the primary focus while in many APAC countries social factors, particularly those related to financial inclusion of under-served communities, tend to take center-stage. In North America, there has traditionally been a greater emphasis on governance issues, particularly around management quality. At an individual level, it becomes even more complex and disparate; one investor may be interested in carbon emissions, while another may be interested in diversity.

New Tools of the ESG Trade

In practical terms, achieving a greater alignment between investor objectives and the investment process will require:

• A deeper understanding of investors’ interests and concerns when it comes to ESG, allowing them to define relevance on their own terms;
• An ability to “open up the box” to explore and identify the underlying components of ESG, how they’re scored, and how they can inform and support specific investment strategies and objectives;
• Customized portfolio construction to reflect investor preferences and needs;
• Demonstrability to ensure preferred ESG factors are represented in the portfolios or fund investments.

Without existing common standards and the disparity across ESG’s data universe, a consensus will likely only form through greater transparency into what investors are doing, which will, in turn, inform best practices.

At Partfield Data and Analytics Solutions, for instance, we are developing an application to leverage the power of the Partfield network to learn how portfolio managers and business users are interacting with and interpreting ESG data. Effectively this will provide crowdsourced guidance around the preferred ESG factors and priorities to determine the materiality of specific data sets and in the process create standards that both guide future ESG investments and continually improve and optimize the effectiveness of ESG metrics to complement traditional fundamental analysis or facilitate non-financial goals.