Performance matters: Achieving responsible returns
In the past five years, ESG scoring systems and data reporting standards have proliferated. Dozens of ESG ratings groups have emerged, each measuring the performance of companies or investment products in different ways.
These varying systems measure companies’ approaches to climate change, environmental issues, diversity and inclusion, human rights, and other social and governance factors, putting different weights on each area when calculating a final score. However, it is not always clear how these scores are decided.
These inconsistencies in methodologies often result in the same company receiving vastly different ratings across different ESG rating systems and platforms. It also means that often ESG scores cannot be linked directly to financial performance.
Instead, investors may use these scores as one input among many in their consideration of ESG risks and opportunities. Many investors are opting to move away from third-party ESG scores, and either using direct data on specific ESG factors or creating their own internal ESG scoring systems according to each investor’s specific investment process.
There has been some convergence in reporting standards for listed companies in the past two years.
In March 2021, the IFRS Foundation announced plans to collaborate with the International Accounting Standards Board and other bodies to “accelerate convergence” on reporting standards.27
Three months later, the International Integrated Reporting Council and the Sustainability Accounting Standards Board announced a planned merger to create the Value Reporting Foundation and pledged to work closely with the IFRS Foundation.28 The IFRS Foundation then formed the International Sustainability Standards Board at the COP26 climate conference in Glasgow, Scotland.29
In the first half of 2022, the Climate Disclosure Standards Board consolidated into the IFRS Foundation29 , the Global Reporting Initiative announced a collaboration with the IFRS Foundation to align the work of their respective Sustainability Standards Boards31 , and the Value Reporting Foundation became part of the IFRS Foundation.32
Regulators and investors have publicly supported these developments as they move towards a more standardized global approach to sustainability data standards. Harmonizing these standards aims to improve data quality and availability, bolstering investors’ ability to assess ESG risks and opportunities across their portfolios.
ESG: Alpha generator or risk mitigator (or neither)?
There is a growing body of evidence from industry-led and academic studies linking positive ESG traits to performance that is in line with or ahead of traditional indexes.
More than 200 studies published since 2015 have pointed to ESG funds and strategies enhancing investment returns, helping stimulate investor inflows.33 For example, research by the NYU Stern Center for Sustainable Business has demonstrated that companies can achieve positive financial benefits from making ESG-related investments. These include realizing operational efficiencies, investing in innovation, mitigating risks, improving sales, and better employee engagement and retention.34
RBC GAM’s Responsible Investment Surveys have shown that most investors expect ESG integrated portfolios to perform as well as or better than non-ESG strategies. Over half of respondents in 2021 said they believed integrating ESG factors could help generate long-term sustainable alpha.
However, as the chart below indicates, a small but fairly consistent minority of respondents has held fast to the belief that ESG portfolios actually perform worse than traditional investments.
How do you believe ESG integrated portfolios are likely to perform relative to non-ESG portfolios?
A meta-analysis from 2021 found that, while there was no “outsized financial return for ESG strategies”, many analyses were challenged by inconsistent ESG data and the various definitions of ESG, sustainability, and responsible investing, making it harder to compare findings directly. Regardless, the research did propose that ESG investing could give investors an advantage in certain scenarios, especially when it comes to potential risk mitigation.35
The concept of risk mitigation as a driver of ESG investment is popular among investors. RBC GAM’s Responsible Investment Survey has consistently shown that many investors see ESG as a risk management tool as much as an alpha generating strategy.