Data Simply Scores: Enhance your SRI and ESG lenses
The pursuit of pure Alpha and recognition of less tangible but equally – or more -- worthy goals, is as old as recorded financial history. In its current incarnation, a financial industry tempered by the “greed is good” era is scrambling to accommodate new generations of investors who place a high premium on environmental and social goals.
These investors are backing up their interest in environmental, social and governance (ESG) issues with growing amounts of money. The equity funds tracked by Informa Financial Intelligence, EPFR have posted collective net outflows of over $225 billion so far this year, with the ESG subset or socially responsible investment (SRI) mandates attracting over $35 billion in 2019.
Investors and fund managers must tackle individual challenges posed by this emerging trend. Each investor places varying emphasis on separate parts of the ESG trifecta. Investors criteria vary, both in terms of duration and the degrees of return, in which each they are willing to forgo to achieve ESG goals. Financial professionals are struggling to find credible tools and benchmarks to construct, test and maintain ESG friendly portfolios with enough flexibility to meet the diverse goals of the investor pool and fiduciary responsibility.
Our partner, Data Simply has responded to this challenge by creating financial and ESG scores for individual companies. Data Simply analyzes corporate filings with the US Securities and Exchange Commission (SEC) word-by-word, classifying key words found in those filings as ‘positive’, ‘neutral’ or ‘negative’ for financial, along with Environmental, Social and Governance (ESG) sentiment.
They add up the number of words and use them to calculate raw scores. These scores show what ESG issues are affecting a company, and if they are in positive or negative financial standing. For ESG investors, this provides a window into the areas where – in those terms – the company is strongest. Makers of environmentally or socially damaging products such as herbicides and cigarettes, for instance, will likely depend on governance to lift their ESG scores.
For greater clarity, Data Simply makes it easy to access underlying keywords and fillings providing investors a granular view into what’s affecting a company. Additionally, investors can home in on words and topics that they believe are most important, pose the most risk or generate positive performance.
What do these ESG scores tell us, and how do they fit into the structured and increasingly quantitative analytical frameworks that are integral to the money management industry.
Research by EPFR’s quantitative research team suggests that the financial scores, when normalized, can add value when used conventionally as factor-driven screens for the Russell 1000 and 2000 indexes. For more details, click here.
For ESG/SRI screening and analysis, the value currently lies in the granularity and cleanliness of the scores that Data Simply generates. Clients also have the option of adapting Data Simply’s screening algorithm to capture different words that they believe carry more weight in their analysis and investment processes.
This flexibility and absence of a ‘one-size-fits-all’ score is particularly valuable when applying ESG screens to sectors which, for obvious reasons, have very different profiles. Heavy machinery maker Caterpillar, for instance, is engaged in lines of business that make it hard to fashion a ‘green’ image. Yet, within the universe of major industrial companies, Caterpillar scores well on both environmental and social grounds (see Chart 1.0 below).
Follow our ESG blog series over the next 5 weeks, where we will focus on five major sectors, top companies within major sectors and more.