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Asset Managers are going ‘All in’ into ESG

Synopsis: High tide raises all ships. What we are witnessing in the ESG space is something similar. Up until January of last year, ESG was still a subtitle in the larger picture of things. But fast forward to July 2021 and within eighteen months, with record billions of dollars of inflows, ESG is no longer lurking at the bottom of the screen. ESG has become the screen. The Covid-19 pandemic suddenly made the entire world conscious of their role in promoting sustainability and that helped the ESG movement. Also, the modern-day investor is aware of their role in making companies accountable for their actions and asset managers had to listen. If the recent acquisitions and developments in the sector are any indicator, ESG is going to be the long-term bet for investors and most importantly, the planet. EMAlpha takes a look at the drivers that are behind the recent surge in the ESG movement and how EMAlpha’s proprietary algorithm can contribute to the momentum.

Why has the ESG space all of a sudden heated up?

In the last week of May, Exxon management lost to a small hedge fund called Engine No. 1 (Will ESG sound the death knell on oil age), which held just a 0.02% stake in Exxon. They got two board seats at ExxonMobil’s annual shareholder meeting and their proposal was backed by New York and California pension funds, two of the largest U.S. pension funds, and powerful asset management firms, including Blackrock and T Rowe Price. When the final votes were tallied, shareholders had elected a third director nominated by hedge fund Engine No. 1 to Exxon’s board. This was a big push for the ESG agenda.

The Net Zero Asset Managers initiative launched in December 2020 and recognized by the United Nations Framework Convention on Climate Change Race to Zero already has 128 signatories and USD 43 trillion AUM, which is almost half of all global assets under management that are committed to Net Zero goals. Net zero means achieving a balance between the greenhouse gases put into the atmosphere and the greenhouse gases are taken out. In other words, Net zero will be achieved when the amount of greenhouse gases humankind emits equals the greenhouse gases it removes. It can also be called carbon neutral. Net zero can significantly contribute to tackling climate change by limiting greenhouse gas emissions.

While there have been other developments in space in recent times that led to more popularity for ESG among asset managers, these two events have contributed their fair share.

BlackRock, LGIM had seen the writing on the ESG wall

Larry Fink, the CEO of BlackRock (the world’s largest Asset Management Company) has been very vocal on ESG issues. In his 2020 letter, Fink focused on climate change, saying that global warming would upend global finance and he promised that his firm would take steps to address the issue across the thousands of companies in which BlackRock invests. And the steps that BlackRock has taken to boost its ESG credentials give merit to the CEO’s verbiage.

Unbeknownst to many, Legal & General Investment Management (LGIM) has been incorporating sustainability metrics into its the US $ 1.8 trillion AUM for quite some time now. It recently dropped four companies (including insurance giant AIG) from its funds for not complying with sustainability practices and disclosures.

Keeping the above in mind, it would be a worthy exercise to see the recent acquisitions and developments that have happened in the ESG spectrum.

Important Acquisitions and Developments in ESG in recent times

Asset Managers see value in ESG investment. And considering everything that has transpired in the past couple of years (Covid pandemic, Amazon deforestation, Australian fires, untimely cyclones, rising temperatures), it becomes imperative for investors to consider the larger issues facing society and the planet while making their investments. There’s no justification for increasing your bank balance while the planet becomes inhospitable. Investors and asset managers are beginning to realize that they can’t miss the woods for the trees. As such the recent acquisitions that have transpired can be said to be a step in the right direction. EMAlpha takes a look at some noteworthy acquisitions in recent times:

  • On Feb 01, 2021, BlackRock reported that it had completed the acquisition of Aperio, a pioneer in custom index equity portfolios delivering tax optimization, targeted risk factors, or ESG (environmental, social, and governance) values, and shareholder engagement.
  • On June 17, 2021, BlackRock announced an agreement with business and technology consultancy Baringa Partners to acquire Baringa’s Climate Change Scenario Model. BlackRock would integrate the model into its Aladdin Climate technology. The agreement would set the benchmark for modeling impacts of climate change and the transition to a low carbon economy on financial assets for investors, banks, and other clients.
  • On January 18, 2021, BlackRock took a minority stake in Clarity AI, a Spanish fintech firm that has a client network with over US $10 trillion AUM. The firm uses big data and machine learning to help investors realize the societal impact of their investment.
  • Very recently there have been talks doing the round that BlackRock is negotiating with IGIS Asset Management, a South Korea AMC with the US $ 34 billion AUM, to acquire IGIS Private Equity (IGIS PE), which specializes in investments in eco-friendly infrastructure. Considering how proactive BlackRock has been in its ESG acquisition spree, this hardly comes as a surprise.
  • On July 15, 2021, Vanguard, the world’s 2nd largest AMC behind BlackRock, acquired Just Invest, a provider of tax-managed, tailored wealth management technology, including Kaleidoscope—a highly customizable, direct indexing offer. This was Vanguard’s first-ever acquisition and marks its jump to direct indexing. Direct indexing is all about ESG, cost-saving, and portfolio customization.
  • On June 29, 2021, JPMorgan Chase agreed to buy OpenInvest, a San Francisco start-up that allows clients to create personalized, dynamic, values-based portfolios. Following the acquisition, Mary Callahan Erdoes, CEO of JPMorgan’s asset and wealth management division said, “Clients are increasingly focused on understanding the environmental, social, and governance impact of their portfolios and using that information to make investment decisions that better align with their goals”.
  • On June 30, 2020, Australian financial services firm Perpetual acquired Trillium Asset Management, an impact-driven, ESG focused firm which has been at the forefront of ESG investing for nearly 40 years.
  • On July 06, 2021, Blackstone announced that Blackstone managed private equity funds reached an agreement to acquire Sphera, a leading provider of ESG software, data, and consulting services from Genstar Capital.
  • On July 06, 2021, Affiliated Managers Group with a total of US $ 738 billion in AUM agreed to acquire a majority equity stake in Parnassus Investments, the largest ESG dedicated fund manager in the US.

From the above discourse, it is evident that the ESG space is red hot right now and Asset Managers are leaving no stones unturned to ensure that their investments align with ESG standards. The acquisitions and partnerships can only be expected to grow as time goes by. For the big asset managers, creating a sustainability framework from ground zero is a time-consuming endeavor. As such these asset managers are willing to shell in a few bucks to acquire an already built technology to capture the biggest piece of the pie.

New ESG ETFs are also being launched

On July 15, 2021, Goldman Sachs launched Goldman Sachs Future Planet Equity ETF. It thus marked its entry into the crowded ESG investing class. The ETF stands out from the other ETFs in that its top five holdings are Enel SpA, Ecolab, Daikin Industries, Xylem, and Ball instead of the usual investor favorite Apple, Facebook, and Microsoft. The ETF is investing in companies working on environmental problems aligned with five themes: clean energy, resource efficiency, sustainable consumption, the circular economy, and water sustainability.

Following its victory over Exxon Mobil, on June 22 2021 Engine No. 1 said that it would launch a fund, called the “Engine No. 1 Transform 500 ETF”, a US $100 million ETF to integrate the army of index investors into its mission of impact investing. Instead of divesting or excluding certain companies or industries from the fund, Engine No. 1 stressed focusing on shareholder voting and active campaigns to bring about sustainability changes along the lines of its battle with Exxon Mobil.

BlackRock Inc.’s U.S. Carbon Transition Readiness ETF which debuted in April has turned out to be one of the biggest active ESG funds of 2021. It is now valued at the US $1.4 billion. The ETF received significant institutional support including from the California State Teachers’ Retirement System.

The first quarter of 2021 has seen net inflows into sustainable focused funds reach a record high of nearly US $ 21.5 billion. ESG is carrying a lot of momentum. According to Bloomberg, global ESG assets are on track to exceed $ 53 trillion by 2025, which is more than a third of the estimated total AUM of $ 140.5 trillion. It is glaringly obvious where the chips are being bet.

How EMAlpha can help

There is, undoubtedly, a profound ESG movement going all over the globe right now. From countries to asset managers, from millennial investors to the old school stalwarts, everybody’s counting on the ESG chip for a better future and a better return on investment. Be it Mukesh Ambani of Reliance Industries Limited or Saudi Arabia’s sovereign wealth fund, Public Investment Fund, ESG patrons keep growing by the day. There is almost an undisputed global consensus that businesses must incorporate sustainability into their operations.

While the ESG deliberation is appreciable, one can’t deny the challenges facing the ESG movement. Be it greenwashing, lack of proper metrics, frameworks, or quality of ESG information, ESG still has plenty of hurdles to overcome for it to be a sustainable investment instrument. It is here that EMAlpha with its proprietary AI-ML techniques becomes a much-needed tool for investors.

  • Go beyond the official reported version – The data source matters and there is a need to look beyond what the companies are reporting and what the official version is. It is essential to rely on the company-reported data because other sources might not be collating as much information. Although often, there are other sources as well for environment-related information. They include the information disclosure as mandated by regulators and the EMAlpha algorithms scan through unstructured data to pick the unofficial information too.
  • No two ESG scores are the same despite the same headline figure – It is the composition that makes a big difference and all the three parameters that constitute ESG need to be evaluated separately. The EMAlpha algorithms provide separate scores for E, S, and G so that an investor can review the sectoral performance more transparently. Over and above, a key feature of EMAlpha’s NLP algorithms is that the attribution analysis is fairly simple.
  • An ESG score without context and background is meaningless – The ESG is as much about intent as it is about execution. For this balanced evaluation, having an understanding of the local factors is very crucial. A very good ESG track record (probably more driven by excellent performance in E and/or S) may hide serious Governance related risks and the investors can only ignore them at their peril. EMAlpha analysis meticulously incorporates this critical part of the ESG evaluation jigsaw puzzle.

References

  1. BlackRock completes acquisition of Aperio https://www.blackrock.com/corporate/newsroom/press-releases/article/corporate-one/press-releases/blackrock-completes-acquisition-of-aperio (Accessed on 17th July 2021)
  2. BlackRock acquires Baringa’s climate change scenario model https://www.esgtoday.com/blackrock-to-acquire-and-integrate-baringas-climate-change-scenario-model/ (Accessed on 17th July 2021)
  3. BlackRock boosts sustainability analytics with a stake in Clarity AI https://www.finextra.com/newsarticle/37291/blackrock-boosts-sustainability-analytics-with-stake-in-clarity-ai ( Accessed on 17th July 2021)
  4. BlackRock in talks to acquire IGIS Private Equity for ESG Investment https://www.koreatimes.co.kr/www/biz/2021/07/175_312007.html?gonw (Accessed on 17th July 2021)
  5. After RIA pilot test soars vanguard group buys just invest to counter disruption bids by rivals in the direct indexing game https://riabiz.com/a/2021/7/13/after-ria-pilot-test-soars-vanguard-group-buys-just-invest-to-counter-disruption-bids-by-rivals-in-the-direct-indexing-game (Accessed on 17th July 2021)
  6. Vanguard acquires just invest for direct indexing https://www.tradersmagazine.com/xtra/vanguard-acquires-just-invest-for-direct-indexing/ (Accessed on 17th July 2021)
  7. JPMorgan is buying an ESG investing platform in bank’s third fintech acquisition of the past year https://www.cnbc.com/2021/06/29/jpmorgan-is-buying-an-esg-investing-platform-in-banks-third-fintech-acquisition-of-the-past-year.html (Accessed on 17th July 2021)
  8. Blackstone to acquire Sphera, a leading provider of ESG software, data, and consulting services from Genstar Capital for $ 1.4 billion https://www.blackstone.com/press-releases/article/blackstone-to-acquire-sphera-a-leading-provider-of-esg-software-data-and-consulting-services-from-genstar-capital-for-1-4-billion/ (Accessed on 17th July 2021)
  9. AMG adds ESG focused Parnassus Investments to affiliates stable https://www.pionline.com/money-management/amg-adds-esg-focused-parnassus-investments-affiliates-stable (Accessed on 17th July 2021)
  10. AMG acquires control of Parnassus, the last big ESG firm. What does this mean for investors? https://www.barrons.com/articles/amg-acquires-parnassus-the-last-big-esg-firm-what-this-means-for-esg-investors-51625867412 (Accessed on 17th July 2021)
  11. Goldman Sachs launches an ESG ETF with a go-anywhere, any size approach https://www.marketwatch.com/story/goldman-sachs-launches-an-esg-etf-with-a-go-anywhere-any-size-approach-11626362288 (Accessed on 17th July 2021)
  12. Engine no 1 to launch $ 100 million ETF focused on ESG engagement https://fortune.com/2021/06/22/engine-no1-etfs-esg-finance-2021/ (Accessed on 17th July 2021)

EMAlpha Products and Services

In most Emerging Markets, information discovery is a major challenge. For example, even if global investors do show interest, how do they solve the problem of timely access to information? The world’s largest capital allocators hold USD 60 trillion and they include GPIF (Japan), GPF (Norway), ADIA (Abu Dhabi), GIC (Singapore) etc. However, only 10% of the capital gets allocated to EMs and ~90% goes to G10. The big hurdle for EMs is: Foreign investors cannot access relevant local information in a timely fashion.

Most market participants and investors from across the world realise that the low rates in G10 makes EM attractive for investors. But, a) Information access is usually a cost and time intensive process for investors, and b) In many EMs, language is a big barrier and because of multiple regional languages, there is a significant delay before news makes it to the mainstream English language. To address these issues, you need solutions like, a) Real time news collection from multiple languages and, b) Instantaneous machine translation and text analytics leading to actionable recommendations for investors.

There are further challenges such as ensuring that companies behave responsibly and that they adopt sustainable business practices. There is a need to ensure that the investors are contributing towards making the world a better place by making investment decisions which reward responsible behaviour of companies. Case in point, ESG (Environmental, Social & Governance) which is increasingly being used as a filter for investment decisions. There are other issues as well such as which data to use and a lack of a standardized framework for evaluation.

Some of these issues are too important to be postponed to a later date and it is in this regard that EMAlpha is making its contribution. 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.

EMAlpha also has solutions for Multilingual data collection and real time targeted information which are based on proprietary processes to collect relevant data across multiple markets. The coverage expands across emerging market equity, currencies and commodities and the work has also been very successful in testing the signals in some key markets for live trading strategies. This is a continuous cycle and a virtuous loop that allows for iterative improvement through AI-human feedback.

With developments in AI and technology in areas like NLP, there are considerable new possibilities to bridge the gap in information between Emerging Markets and the more Developed Markets. This is an area which is turning out to be very exciting because some of the tools mentioned were not available even a couple of years ago. This implies that the evolution in the field will only get faster as time goes on. While the Emerging Markets and the Capital Flow Conundrum is a complex one, there is now much more hope and optimism that with the usage of technology, things will only get better.

At EMAlpha, the ESG team is doing further research on why some issues like Social get more prominence as compared to others like Environmental or Governance issues. To look at specific cases in the context of ESG is a very intense yet interesting exercise and this has been an incredible learning experience for the EMAlpha Research team. The data, information and ratings are a humongous challenge for ESG and it takes time to reach to the depth of the issues as the field is evolving very quickly.

EMAlpha is making a solid contribution in tackling these challenges. EMAlpha has solutions for ESG which are practical, user friendly and although not too simplistic yet easy to use. 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 in order to make it operational and that will be the most critically determining factor for ESG’s success in making the corporate responsibility actually work. Most importantly, the investors should view ‘E’, ‘S’ and ‘G’ individually and should not confound issues when it comes to the comprehensive ESG evaluation. It is important to understand the right reasons behind ESG investing because this bias could hurt their investment decision making and portfolio performance.

Research Team
EM Alpha LLC

For more EMAlpha Insights on Emerging Markets, please visit https://emalpha.com/insights/. To know how you can use EMAlpha’s unstructured data and ESG (Environmental, Social and Governance) solutions for better investment decisions, please email us at research@emalpha.com.

About EMAlpha:

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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