Not enough history to quantify ESG correlation

Environmental, social and governance (ESG) investing is easier said than done as the strategy is still in the early stages of adoption, according to a senior executive at Singapore-based Stradegi Investment Management Consulting (Stradegi).

Vivek Jamwal, practice head of risk and research at Stradegi, says there are multiple challenges when asset managers try to integrate ESG into an investment and research framework.

Most of these challenges revolve around the quantity and quality of the data, the majority of which are “disclosure-based, binary and unverified”, Mr. Jamwal says in a recent interview with Asia Asset Management. Even ESG rating companies “follow different methodologies in arriving at ESG scores and have a correlation score of 0.32, implying that ratings have weak correlations”.

According to Mr. Jamwal, current ESG research can be “backward looking”, and may fail to capture anticipated changes in the ESG factors of companies. In other words, if a company is undergoing a plan to make its business model “greener”, these efforts may not be reflected in the ESG score.

He believes an active management approach may be better than a passive one for ESG integration.

“If one were to approach ESG in a similar manner to factor investing and use a passive smart beta approach, it may not work,” he says. “Overall, ESG is a new strategy, and there is not enough history to quantify whether ESG scores directly correlate with performance.”

In his view, it will take a full economic cycle to evaluate the performance of ESG.

“However, if one were to take an active approach with ESG, the story would be very different,” he says.

According to Mr. Jamwal, if managers “investigate and integrate the ESG factors into the research process using an active management approach”, it could result in a new and comprehensive set of metrics that they can track.

“This in turn could potentially translate into performance advantages over a longer time horizon,” he adds.

He points out that there are no valuation models that use comprehensive ESG factors to gauge a company’s true value.

“Hence, we are recommending that ESG factors serve as additional inputs into the current valuation methodologies and the investment process,” he says.

This means, as companies disclose more data on their ESG factors, they could help buy-side managers have a better picture of a company’s strategies and operational processes.

“Therefore, the additional data points will only help get a better picture of the companies, without deviating materially from their existing investment process,” Mr. Jamwal explains.