Industry Stories

Using Data to Gain an Advantage in ESG Investing

Data is now the fuel that propels companies and industries. However, the opposite is true for a great many environmental, social, and governance (ESG) investors, who often struggle to make sense of contradictory and sometimes irrelevant data points.

Companies frequently receive conflicting ratings from respected ratings agencies. One researcher found that the leading ESG agencies had just a 30% correlation among their ratings. By contrast, credit ratings agencies agreed 99% of the time.

When Statista surveyed asset managers and owners about ESG investing, the research firm found that 39% considered data quality and consistency a main barrier to further investment. Nearly the same number — 38% — point to inconsistent data across asset classes as an important hurdle.

This can leave investors wondering who is to be believed.

Infosys conducted a global survey of 455 investment and fund managers to better understand how they use ESG data and ratings and assess the resulting benefits. Two of the key findings pointed to data’s function as an obstacle or an advantage. Broadly, survey data found the following:

• Overall, investors’ internal ratings beat the ratings generated by external agencies.
• Not all ESG data sources are equal, and they often differ in surprising ways.

Do your own research

Investors seem to understand the value of doing the math themselves. More than nine out of 10 firms relied on in-house ratings only or a combination of in-house and external ratings. These approaches produced noticeably better results than those for companies that relied entirely on external ratings, a sign that firms can use their data analytics expertise to find edges in ESG investing strategies.

Firms that used only external ratings reported returns 6.47% higher than the S&P 500. Investors that relied only on internal ratings said their returns on average were 6.78% higher. And when they combined internal and external ratings, the increase jumped to 6.9% above the baseline.

Figure 1. The best-performing investment firms combine internal and external data

Source: Infosys Knowledge Institute

However, our research did find an advantage that many investors missed. We evaluated the data sources firms used to develop their own internal ESG ratings, either data directly from the target companies or the raw data provided by ratings agencies. Investors that used company data to create their internal ratings performed 1 percentage point better than competitors that relied on external ratings. The firms that used rating agency data — not just the ratings — performed 0.8 percentage point better than those that used only the external ratings.

Surprisingly, almost none of the investors surveyed combined both types of data. Perhaps they presumed both sources were essentially equal. But the data obviously is capturing different factors. Our analysis found that firms that use both kinds could see investment performance 1.8 percentage points higher.

Choose the right ratings

Our research found that the more data companies used, the better their ESG investment performance. Even so, we found more volatility than expected in the performance of the various ratings agencies, either through their ratings or the data they provide.

Some of the agencies were used by nearly half the investors surveyed, and others were used by just a few. However, the popularity of the ratings agencies didn’t necessarily correlate with the performance of the investors that use their ratings or data. Some of the most popular agencies had no effect on ESG investment performance. At the same time, firms that used one of the less popular agencies reported significantly better investment performance.

This suggests that there is still a great deal to learn about what factors matter the most in ESG investing and which data sources will make the greatest difference.

A necessary strategy

Investing in ESG is no longer a side focus; it’s rapidly becoming mainstream, and firms that move confidently in this direction can profit in multiple ways.

Growing the green economy — The stakes are no longer those of a niche market. Sustainalytics projects that the ESG investing market will reach $50 trillion in the next five years — offering vast lending and investment opportunities as well as risks. Investors should not underestimate this economic shift.

Competitive advantage — Stakeholders are now considering ESG pledges and actions when making financial decisions. Institutions need to show that their actions support these sustainability commitments and avoid the risk of greenwashing. Firms are increasingly judged on their ESG credentials.

Reduce risk — National governments are demanding greater sustainability — particularly related to climate change — from companies. These can either show up as regulations or incentives. This will change the course of entire industries and economies and give an advantage to those on the leading edge.

The great gains made by ESG investing in the past couple of years have opened the eyes of investors. However, it is easy to look smart during a boom. As ESG investing gets past this initial surge, firms will need to scrutinize their strategies — and the data that underlies them — more thoroughly. The data is almost certainly telling us something. But we’re not yet hearing the full story.