ESG: A package deal

From the outside looking in, sustainable investment analysis may seem like information overload. Amid all of the data, is it possible to see both the forest and the trees? Rathbone Greenbank deputy head of research Kate Elliot says yes.

Countryside lane

By Kate Elliot

Every once in a while, I need to immerse myself in nature. Like anyone else, the trappings of the modern world can feel a little overwhelming at times, be it parenting, Zoom calls, or simply braving  B&Q on a rainy Saturday afternoon.

Sometimes nothing clears my mind and recharges my batteries better than finding a quiet trail in the countryside where I can escape the noise and business of the city. It’s the simplicity of it that I like – especially after a working week spent trying to make the complicated seem straightforward.

I imagine many investors might feel overwhelmed by the information being thrown at them, particularly on the sustainability side of things. For starters, no one can decide what to call it. Is it responsible investing? Sustainable investing? Ethical investing? Impact investing? Talk about a big hurdle to clear before we’ve even got started.

Then there is the question of how anyone determines if a company can be considered truly sustainable. There are so many variables and criteria, you’d be forgiven for not knowing where to begin or how to make sense of it all.

If you spend too much time looking at all of the individual parts in isolation, you can quickly lose track of it all and you won’t be able to see the wood for the trees. You need to step back and take in the bigger picture.

There is an increasing quantity of data and metrics for determining a company’s sustainable investment credentials, ranging from carbon emissions to governance and corporate culture. Our sustainability and Environmental, Social, and Governance (ESG) framework includes 30 top-level criteria and then a further 300 sub-criteria that we can choose from when assessing the sustainability credentials of a given company or entity.

We filter out the noise and decide on the most important issues given our understanding of a company’s activities and the industry in which they operate. The information we collect is then run through an algorithmic process that generates a score for each company on each issue that we assess.

But we don’t just blindly follow the numbers – this ranking system helps us determine a company’s sustainability strengths and weaknesses, but just as important is our overall assessment of corporate culture and its commitment to sustainable development. Many companies talk the talk and produce mounds of data and reports designed to convince the world of their achievements, but quite often once you scratch the surface it becomes quite clear they aren’t walking the walk.

So, by looking at how a company is managing environmental, social and governance issues we can get a good idea of whether or not it is appropriate for a responsible investment portfolio. And it’s important to take a holistic view. Of course, it’s great if a company has moved to fully renewable energy and built a sustainable supply chain, but what if it also has a negative corporate culture and is known for serious health and safety breaches – how do you balance these different aspects?

Some critics suggest that bundling ESG together in a single fund results in a lack of focus and instead they should be tackled individually. The theory goes that if you want to invest in companies that are friendly to the planet and will help to reduce pollution, focus on the E in ESG, while if you want to invest in companies that will perform well financially, focus on the G, and so on.

The problem with that thinking is that it suggests the three are not connected in any way. Sure, a company does not need to be sustainable to have good corporate governance, but that isn’t the point of responsible investing. Our aim is to build investment portfolios that contribute to sustainable development and you can’t do that by focusing on a single issue in isolation. For example, you’re not going to solve climate change without looking at food and nutrition, inequality and water security.

We could focus entirely on the environmental side of ESG, but that will mean directly ignoring at least half of the 17 Sustainable Development Goals, and indirectly undermining many of the others. This is why we think it makes sense to take a wider view. Of course, individual companies or entities might be focused on a particular issue, and that’s fine, but we need to make sure that their activities or business practices aren’t causing harm in other areas. 

In an ideal world, companies would work this out themselves and focus on operating as responsibly as possible. But that doesn’t always happen and so investor engagement is hugely important in shifting the dial. If investors like us didn’t prod companies and their management teams to up their game across a range of sustainability issues, then I doubt ESG would have made as much progress as it has so far.