After 2020 as its breakout year, the Top 3 Most likely themes for ESG in 2021
‘Never waste a good crisis’ is often the advice meted out, whenever a fundamental shift is needed and an overhaul of the entire process of ‘thinking and doing’ is required to get rid of the old and usher in the new. Winston Churchill may have said this during World War II and that too in a specific context, but questioning the status quo is indeed easier during challenging times and it is much more viable to doubt the accepted reality when things are going south. ESG (Environmental, Social and Governance) and Sustainability issues have been actively talked about for more than a decade now, but there is no doubt that the ensuing crisis, as a result of the Covid-19 pandemic has been a big contributing factor in making them more mainstream.
While it is yet to be seen how permanent this change will be in terms of how companies, their investors and customers, the media and the general public think about the need for a more ‘sustainable in the longer term’ model of capitalism, it will be virtually impossible to dismiss 2020 as yet another year for the discussions on the relevance of ESG issues. This year, there were several important developments which were viewed as the direct effect of the Coronavirus pandemic, including, a) more and more investors beginning to see ‘good returns on investors’ and ‘Responsible Corporate Behaviour’ as objectives which is not consistent, b) the ESG Funds continued to see exponential rise in AUMs and also delivered in terms of performance, c) the companies also started to focus on their ‘Sustainability credentials’.
It is very likely that the increasing importance of issues like climate change, diversity and the need for more transparency will continue to remain relevant and also the more environmentally and socially conscious Millennial investors will continue to drive inflows into ESG Funds. However, the rising popularity of ESG doesn’t ensure that 2021 will be a smooth ride. Among the most important themes which would be discussed broadly in the year 2021, EMAlpha Research team tried to capture the ones which are going to have the maximum impact and the Top three picks are:
- Need for more consistent and independent data on evaluation of ESG performance of companies,
- Increased scrutiny on what the ESG funds are saying or claiming vs. how they are investing, and
- More methodical and systematic approach by companies on how they will formalise the inclusion of ESG issues in their day-to-day working.
Firstly, as Investors are starting to look at ESG filter more closely, they are becoming more aware of the inconsistent and often poor quality of available data. While it is true that the investors are spoilt for choice when it comes to choosing a vendor for their ESG related data requirements, the market fragmentation and the huge number of choices available doesn’t really help. Then there are also issues like, a) company reported data vs. data from public sources and information from specialised non-official sources, b) even when companies report voluntarily on sustainability related information, the format is often different across one industry or even a sub-sector, c) the challenges relating to more important issues in a particular market and how to rate them. The list above is certainly not exhaustive but the task still looks daunting and in 2021, this will be discussed as a recurring theme.
Secondly, very often, the fund managers running ESG Funds view the companies and their track record on sustainability and business resilience topics very differently. How the portfolio managers running the ESG investing mandates, will select or reject companies is still not completely transparent in most of the cases. This makes it more difficult for the investors and many of them do realise that it is not sufficient to put in money into ESG Funds. The decision has to be more granular with issues, an individual asset owner or investor tending to be more passionate about and then comparing it with the philosophy of the asset manager entrusted with managing the corpus. It is also possible that many of the investors have gotten attracted to ESG funds because of their excellent performance in 2020, but often the underlying reason is sector skew and not necessarily any big differentiating factor on ESG. These sector specific performance trends are never linear and asset owners will be tested more in 2021.
Thirdly, the companies will focus on highlighting their proactive stance on ESG issues. There will be more examples like Volkswagen which has announced that it will link its top executives’ bonuses to ESG targets and will seek shareholder’s approval in its next Annual General Meeting. As more companies talk about their intent and plans on ESG, the fund managers in particular will require to make assessment on several different dimensions such as, a) what is real change and what is pure Public Relations exercise, b) how does the proposed changes impact business performance and operational profitability, and c) how the changes are consistent with direct or indirect impact on ESG parameters. Not to mention the rules governing ESG which are still evolving in most jurisdictions and which companies will undoubtedly comply. But this is not an easy challenge to overcome and it is a safe bet to expect more on this in 2021.
The data, information and ratings are a humongous challenge for ESG and it will take time. EMAlpha is also making its contribution in tackling this. EMAlpha has solutions for ESG which are practical and user friendly. For example, EMAlpha has developed a Flexible ESG Framework Management System which is a proprietary technology that makes ESG scores framework agnostic, thus allowing for quick adaptation. In addition, the users decide what matters to them and the EMAlpha system does a classification into E, S, G and more granular categories. We strongly believe that the entire ESG ecosystem requires multiple stakeholders to pull in the right direction to make it operational and that will be the most critically determining factor for ESG’s success in making the corporate responsibility actually work.
EM Alpha LLC
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EMAlpha, a data analytics and investment management firm focused on making Emerging Markets (EMs) more accessible to global investors and unlocking EM investing using machines. EMAlpha’s focus is on Unstructured Data as the EMs are particularly susceptible to swings in news flow driven investor sentiment. EMAlpha works on information discovery and ESG solutions for Investors in Emerging Markets, using AI and NLP tech. Our mission is: “To help increase capital flow, in terms of FDI and FPI, to Emerging Markets by lowering information barriers using AI/NLP”. EMAlpha Products help achieve both alpha and ESG solutions and the idea is to help asset allocators, asset managers, banks and hedge funds along with companies with cost and time efficient access to relevant information. We use thoroughly researched machine learning tools to track evolving sentiment specifically towards EMs and EMAlpha pays special attention to the timely measurement of news sentiment for investors as these markets can be finicky and sentiment can be capricious. Our team members have deep expertise in research and trading in multiple Emerging Markets and EMAlpha’s collaborative approach to combining machine learning tools with a fundamental approach help us understand these markets better.
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