Kipp Cummins, Head of EMEA Fixed Income, Dimensional Fund Advisors.

The difficulties for fixed income managers to work with existing ESG data and provide emissions and Scope 1 and 2 information were a challenge that some think will take a long time to fix, which could prove a headache for fund operators, said Kipp Cummins, Head of EMEA Fixed Income, Dimensional Fund Advisors.

Cummins’ thoughts were in Clear Path Analysis’s Investing in Fixed Income Europe 2022 report that also featured insights from AXA Group, XPS Group, Janus Henderson, and Pictet Asset Management.

“We’re a systematic manager and therefore heavily reliant on data,” said Cummins. “Because of this we want to be very cognisant of the limitations and challenges that exist within ESG data. ESG data can vary dramatically in scope, consistency, and reliability.”

A 2020 OECD report confirmed this problem, and said there is a “wide variety of metrics, methodologies, and approaches that, while valid, contribute to disparate outcomes.” This also adds “to a range of ESG investment practices that, in aggregate, arrive at an industry consensus on the performance of high-ESG portfolios, which may remain open to interpretation.” These factors could lead operators and managers to be hesitant to engage with ESG, even as it becomes more and more mainstream.

“If companies are all disclosing different ESG metrics, the reporting is going to be patchy at best. If an investor can’t compare ESG metrics from one company to the next, how useful it is really going to be as part of the decision-making process?”

On top of this issue, disclosure of ESG metrics by companies is still voluntary in most markets, explained Cummins. “If companies are all disclosing different ESG metrics, the reporting is going to be patchy at best. If an investor can’t compare ESG metrics from one company to the next, how useful it is really going to be as part of the decision-making process?”

Cummins, however, does believe that the industry is moving in the direction of integrating ESG practices regardless of its shortcomings. “Emissions data, for example, is now widely available, at least when looking at Scope 1 and 2 emissions,” which includes fuel and power usage. “In addition, we were quite pleased about [last year’s] announcement of the International Sustainability Standards Board (ISSB) among the major accounting regimes, which sought to consolidate some of these disparate reporting bodies.” He added that the ISSB will likely increase harmonisation in terms of what and how ESG data should be reported.

“For a lot of organisations that don’t have a dedicated ESG data team, it may be easier to take the route of just relying on third-party ESG ratings."

However, ESG is still a developing market and many of its rules are still being written. With this being the case, are ESG ratings a viable shortcut?

“For a lot of organisations that don’t have a dedicated ESG data team, it may be easier to take the route of just relying on third-party ESG ratings,” he said. “But while these ratings might have their use, investors need to understand the pitfalls that are associated with taking them at face value.

For example, he said, there can be a lot of contradiction and disagreement about who is more or less sustainable from an ESG perspective. One example he gives is of the electric car manufacturer, Tesla, which will look great if you care about environmental sustainability, Cummins adds, but if your priority is corporate governance or worker rights, then it might be a different story.

“If you are running portfolios that are based on ESG ratings, you need to be able to address these points with your clients. You need to be able to tell them with certainty that you believe one provider has it right relative to another provider,”

By contrast, when you look at credit ratings, you don’t get the same confusion. “An MIT study found that the correlation of ESG ratings from different providers was just 0.54, while the correlation between credit ratings was closer to 1.0,” he said. “So, there is a lot of disparity in ESG ratings, and it really comes down to what is being measured and what the rating agency thinks is important.” Again, he adds, views on ESG are subjective and what is a key driver of a positive score for one provider will not be the same for another.

“If you are running portfolios that are based on ESG ratings, you need to be able to address these points with your clients. You need to be able to tell them with certainty that you believe one provider has it right relative to another provider,” said Cummins. “This comes back to understanding what goals you are trying to achieve and assessing whether a particular ESG ratings provider aligns with those goals.”

To read the interview in full, and the rest of the report, please click here.

 

Please Sign In or Register to leave a Comment.