Sustainability and subjectivity: Navigating the uncertain waters of ESG data
Wednesday, February 26, 2020
February 2020
A more in depth exploration of key sustainability topics
Sustainability and subjectivity: Navigating the uncertain waters of ESG data
Included topics

Human judgment and insight is vital to appreciating and communicating the nuances around sustainability.

“You never change things by fighting the existing reality. To change something, build a new model that makes the existing model obsolete.”  —Buckminster Fuller, Critical Path, 1981

It’s no secret that interest in environmental, social and governance (ESG) investing is building: according to Morningstar data, ESG funds attracted $8.9 billion in the first six months of 2019 alone, compared to $5.5 billion in the whole of 2018. Armed with an expanding body of evidence that corporate behavior across diverse industries impacts the world around us and presents a legitimate financial risk, shareholders and institutional investors alike are increasingly demanding action. Recent events suggest that this enhanced pressure is driving, in part at least, the desired responses: since 2016, the number of Fortune 100 companies using proxy voting to showcase their corporate sustainability and citizenship initiatives has more than doubled. Earlier this year, and in response to shareholder activism, Canada’s largest pension fund “quietly divested from two American private prison operators deeply involved in the detention of thousands of Latin American migrants at the southern border of the United States.” Meanwhile in the U.S., fossil fuel giant ExxonMobil and banking behemoth Citigroup have acquiesced to shareholders pressing for more transparency as it pertains to climate risk and gender pay disparity, respectively.

However, it would appear that, as enthusiasm grows for this expanding space, so too does the counter-narrative. For some, the unfamiliar territory of ESG investing can be intimidating, making it easier to shy away from or dismiss what we consider to be the inevitable: a future in which all investing is sustainable.

The Concerns

Uncertainty or confusion around ESG data usually hinges on one of two factors: consistency (i.e., agreement among different ESG data sources) and materiality (i.e., financial relevance). Although neither is an unreasonable concern, we believe each can be addressed rigorously.


ESG ratings from major providers agree substantially less than investors would like, correlating around 60 percent. By contrast, credit ratings from major providers correlate around 99 percent. This disparity can make it difficult for investors to choose a single ESG ratings provider and erode confidence in the validity of ESG investing in general.

There are a couple of reasons that a company’s ESG score might vary between different ratings providers: First, the aggregate scores themselves might, in fact, reflect a quite different underlying set of sustainability topics. For example, one rater might consider a company’s record on greenhouse gas emissions, gender equality, human rights, and lobbying when assigning an overall score; meanwhile, another rater might not incorporate lobbying in its scoring model.

Then there are situations where ratings providers might be considering the same topics but measuring them in quite different ways. For example, two ratings providers might score companies on carbon emissions, but one might measure only each company’s own direct emissions, while another might measure each company’s direct emissions plus the emissions of its suppliers.

In another scenario, these ratings agencies might measure the same things, but emerge with very different views regarding which issues are most important to a company’s overall score.

Without diving deep into the methodologies of different ratings providers, it can be hard to identify the source of ratings disagreements, which can leave investors uncertain about where to place their trust.


In recent years, there has been a growing acceptance among the investment community that environmental, social and governance issues represent financially material risks. According to the Sustainability Accounting Standards Board (SASB), financially material issues are those “reasonably likely to impact the financial condition or operating performance of a company and therefore are the most important to investors.” For example, one would expect a U.S. pharmaceuticals company to have robust waste and hazardous materials management processes in place—not only does this safeguard human health and the environment, but it minimizes the risk of hefty Environmental Protection Agency (EPA) fines that can affect the bottom line. In this scenario, sustainability benefits and financial benefits are aligned, and it’s a win-win.

However, not all sustainability topics are equally material for all companies. For example, firms domiciled and operating in countries with less regulatory oversight may be less exposed to financial risks from government fines. And, just because a data point doesn’t present as financially material yet doesn’t mean we should disregard it entirely. It may be significant in the context of an investor’s personal ethics, or it could be material in ways we have yet to identify. As we’ve discovered, materiality estimates are subject to change—markets comprise different stakeholders, whose values and norms might evolve over time. In fact, one recent study outlined two distinct catalysts that might cause a previously overlooked piece of information to be viewed as material: in the first instance, “company behavior moves away from what is currently considered socially acceptable. In the second case, it is societal norms about what is acceptable corporate behavior that move away from current practices.”

One recent example of the latter? Just look at how, prior to abandonment of its IPO, WeWork hastily added a woman to its board amid public backlash surrounding the company’s lack of diversity and an alleged “frat boy” culture. Even as recently as a decade ago, an all-male board might not have attracted such intense scrutiny—but, of course, norms change. Data alone can’t always tell that story, and that’s why we believe strongly that effective ESG integration requires a keen understanding of the underlying issues.

Each of the scenarios outlined above might indeed be cause enough for a fund manager or investor to throw up their hands and ask, “What’s the point?” But bear with us. With so much at stake when it comes to issues such as climate change, it’s surely worth examining a better path forward to impact.

Elements of Effective ESG Integration

ESG skeptics have legitimate concerns, and it would be disingenuous to suggest that we have all the answers to persuade them, but we do believe that there are several components that are key to instilling trust and creating meaningful impact:

Expert analysis

Much as human decision-making is key to many other financial domains (including, for example, private equity fund selection), we believe that it is an invaluable and often-overlooked component in assessing corporate behaviors and impact. Diligent and thorough human analysis is key to understanding something as inherently complex as how corporate behavior affects the society and environment—and concurrently, how that same behavior jibes with clients’ values. The careful vetting, processing and incorporation of data points, as well as ongoing examination of academic research, can facilitate greater comprehension of precisely which information is material to the causes that clients care about most.

Multitudinous data

Simply relying on single sources of third-party data, which only paint a partial picture, is almost certainly not the best path forward. Instead, asset managers may wish to develop their own processes or partner with a vendor that uses multiple sources to disaggregate ratings, parsing various vendors’ scores to distill them down to the most impactful components. In doing so, they can gain a deeper understanding—and better help clients to understand—the material risks associated with each of the issues.

Sector weighting

Another critique of ESG data focuses on a perceived inability to account for industry sector bias, meaning that composite ratings uniformly assess companies under the same model and fail to account for their significantly different risk exposures and business models.

This is certainly valid, and we agree that to ignore such variances would be unwise. Different companies are exposed to different sets of material ESG risks, and those risks vary in importance depending on the industry. For example, we would expect an oil and gas extraction company to have much more stringent policies regarding greenhouse-gas emissions and waste management than say, a software and services company. But it’s possible to account for these differences and more—by looking at factors such as the geographies in which companies are domiciled and do business, the industries in which they operate, the size of their business, and various other factors—when assessing material risk.


It is incumbent on asset managers to engage in ongoing dialogue with clients, enabling them to grasp the degree to which certain corporate behaviors affect the issues that they care about most. Clients may look to financial professionals for education regarding the trade-offs associated with certain sustainability goals—for example, an individual might want to exclude companies that are involved in the burning of fossil fuels, while simultaneously prioritizing companies that invest heavily in renewable energy. The only catch? Those two, in many instances, are one and the same. Amid all this complexity, the onus is on financial professionals to help investors make sense of the myriad signals emerging from the financial markets.

A path forward

As the industry continues to demonstrate that ESG integration may yield financial benefits, and as concerned shareholders exert increasing influence, we will likely see a proliferation of new data disclosures from public companies. We’ve begun seeing encouraging results in the form of expanded environmental and social reporting, but it’s unlikely we will ever have access to every piece of data we want.

That doesn’t mean we should stop trying to make a difference. It just means we should strive to learn enough of the story to make informed decisions and, as new metrics become available, continue to evolve our models. As part of this ongoing process, we need to make astute judgments about how best to use the data accessible to us, determining what is relevant and material to each company.

Some in the industry may remember the furor about robo advisors, and the debate as to whether they would ultimately replace human financial professionals. It would appear that reports of the asset manager’s demise have been greatly exaggerated. In fact, the data suggests that the outlook for personal financial advisors is far from doom and gloom: according to the Bureau of Labor Statistics, over the next eight years, employment in the field is projected to grow faster than the average for all occupations. One executive chalked this up to the fact that robo-advisors “fail to account for the complexity of financial planning”; another contended that “money is emotional and there are always intangibles to consider in deciding what to do next, which cannot be captured by robots.” This is eminently true of sustainable finance, too—a concept that becomes doubly emotional when you consider the inherently personal nature of ethics and values.

Just as clients value the deep expertise that advisors bring to the table, as opposed to an algorithm or app, human judgment and insight is vital to appreciating and communicating the nuances around sustainability. And much as investment advisors have embraced change and continued to deliver value to their clients amid a rise in passive index funds and market volatility, the sustainable investing community must continue to strive for better. But that change won’t come from complacency or cynicism; it will come from a cogent and concerted effort to do better—for our clients and for the future of our planet.

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Sources and footnotes

Johny Mair was raised in Australia, and driven by love of technology, collaborating, and bringing ideas to life. He has been building technology products across three different continents and led product teams at Deutsche Bank, JPMorgan, BlackRock, Fidelity, Guy Carpenter, Goldman Sachs and a number of high-growth startups before co-founding Ethic. He studied Mechanical Engineering at Queensland University of Technology.

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