How can we show clients ESG is integrated?

Quilter Cheviot's Gemma Woodward says ESG data can only provide part of the picture

The rapid rise of responsible investment has necessitated an increased demand for reporting on ESG metrics and factors. But with this increased reliance on data comes the danger that, in what would seem a paradox, we actually get a murkier picture of the performance of a portfolio in relation to ESG factors.

We often see reports produced by investment firms using third-party data, which rates a portfolio or a fund based on ESG metrics, and more often than not this rating is better than the benchmark.

But can this really be relied upon? There is no global framework for data providers to follow, so each will interpret information in different ways and will have different biases as to how they weigh the different factors behind that score.

The score from a third-party data provider also reflects their view of the underlying holdings within a portfolio. It does not reflect the work undertaken by the investment firm in regard to ESG integration, as well as the voting and engagement that has been undertaken.

There could also be question marks around the data if it comes from just one provider. Relying on just one provider is far from best practice given that data providers all have different skews.

Most importantly, for discretionary investment managers at least, the work undertaken by research teams to consider ESG factors across asset classes, as well as engaging and voting on monitored universe holdings cannot be incorporated into any score that is provided by a third-party ESG data provider.

The rating will be a static figure, a one-dimensional rating. Thinking about ESG involves much more than this, and it’s this we need to convey to our clients.

Stewardship and data gaps

This is particularly true if we think about stewardship. Stewardship is about engaging with companies and funds to understand the ESG issues that impact them, and voting (where applicable) to ensure positive stakeholder outcomes. Engagement topics vary enormously, they will include climate transition planning, remuneration, board composition, corporate behaviour, disclosure as well as thematic discussions.

Engagements are rarely one-off in nature, they can often span months and years. It is the ongoing dialogue that allows us to hold companies and funds to account that can make so much difference.

Using a metric from one external provider is simply a number and it is hard to discern how that fits into portfolio construction.

Then there’s the issue of data gaps. Often when portfolios are given a rating, not all the assets will have actually been assessed if the data provider does not cover all the holdings within the portfolios. The score therefore may not reflect the true position of the portfolio. 

Although receiving a ‘gold star’ ESG rating for your investment portfolio might give you the feel-good factor, it can be misleading and not a true reflection of the breadth of the responsible investment work being undertaken by the investment manager.

Change is afoot in 2022, as the Financial Conduct Authority is developing proposals for an investment labelling regime, which will eventually result in a standardised product classification system to help consumers understand the sustainability characteristics of different products on the market.

See also: – SDR consultation: Using ‘transitioning’ in fund labelling is misleading

While the clarity this will provide is extremely welcome, it really will only provide clarity for product-based solutions. It will not be possible for the discretionary market to apply individual labels to discretionary managed portfolios, which often number in the tens of thousands. Therefore, the conundrum for us is how to provide clients with the assurance that we are integrating ESG into our decision making. Of course, we have our own view on how to do this, but others would be very welcome.


Natasha Turner

Natasha is global editor at ESG Clarity, part of Mark Allen Financial, and has been a financial journalist for seven years. She has been shortlisted for Story of the Year and Investment Journalist of the...