Understanding and Using ESG Metrics


Stanford Business Graduate School Blog

August 11, 2014



I started out my search for a summer internship looking for opportunities where finance and sustainability converged. Naturally, impact investing was one the fields where I started to look for opportunities, and managed to find a summer position at Sonen Capital, an impact investing fund-of-funds. One of my main interests was to understand the relationship between sustainable business practices and long-term financial performance, and the extent to which these practices could either reduce a firm’s risk profile and/or enhance its return profile, consequentially affecting its risk/reward ratio. Furthermore, I wanted to gain insight on the mechanisms used by PRI signatories to assess Environmental, Social, and Governance (ESG) performance in the firms they choose to invest in, and to what extent ESG-based investment decisions will (hopefully) guide investment capital toward more sustainable firms and/or industries.


Sonen, as a fund-of-funds and PRI signatory, presented the optimum viewpoint to better understand the relationship between financial and ESG performance across several asset classes and fund managers, as well as providing an opportunity to understand how impact/sustainable investing firms complement the available ESG data with their own assessment of the sustainability-related performance of particular firms and the industries in which they operate — all of this while accounting for client’s expectations in terms of financial return and perceived impact.


The main project on which I have been working consists of integrating the different mechanisms through which ESG data is compiled, analyzed for completeness and representativeness, and then used to analyze the ESG performance of Sonen’s investment products vs. that of their corresponding benchmarks. Working on this project has allowed me to gain deeper insight into the methodology and rationale employed to define ESG metrics, and how ratings are determined by different ESG data service providers. Furthermore, it has allowed me to understand their limitations in relation to coverage and accuracy, and more importantly, get a sense of how the incorporation of ESG metrics into investment decisions is becoming widespread among fund managers.


So far my first impression is that while current ESG providers do an adequate job of compiling and providing ESG performance data for fund managers, there is still room for improvement. Probably the largest steps looming in the horizon are the integration of the different but complementary disclosure standard setting bodies, namely those developed by the <IR> and GRI, as well as the incorporation of the SASB reporting standards into all SEC 10-K filings. These steps will assist firms in easily determining how (methodology) and what (materiality) information needs to be disclosed, giving investors access to ESG/sustainability performance data that is comparable across industries and material to each particular industry. Hopefully the data generated will allow the financial industry to adequately analyze the relationship between ESG and financial performance over varying investment horizons.


Posted by Mateo Musso, 2014 SMIF Fellow, Stanford GSB


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