Do investors have the ESG expertise necessary?

Here’s a note from Nawar Alsaadi:

Here is a typical exchange between an asset owner and an asset manager on ESG integration:

Asset owner: Are ESG factors evaluated along side fundamental factors? Also, could you speak to how you engage on ESG topics?

Asset Manager: Yes, since 2020, ESG factors are reviewed along side fundamental factors by all analysts and investment teams. Likewise for engagements, they are also undertaken by fundamental analysts and PMs directly. All our fundamental analysts have SASB credentials and CFA ESG certifications.

The asset manager’s answer would probably lead to high praise by the asset owner, this is because most asset owners will fail to ask the next, and perhaps the more crucial question, “how many analysts did you have prior to integrating ESG factors and how many do you have today?”

The spectrum of ESG topics (both material and non-material) is vast. Analyzing these topics in depth, and properly engaging portfolio companies on them takes a tremendous amount of time. Fully integrating ESG tasks in the fundamental analyst and PM list of responsibilities means the universe of companies overseen and managed by that individual would have to shrink, otherwise, the quality of the work will diminish. This point is fully lost on those who have no money management experience.

The above brings me back to the topic of a lack of proper ESG integration resources both at the asset owner and asset manager side. Although, the long-term goal of the industry is to fully integrate ESG and fundamental factors, at this stage, these two streams of knowledge remain distinctly separate. Asking a fundamental analyst to fully integrate ESG factors in their work is akin to merging the profession of a pharmacist and a doctor into one; they are related but they do require a distinct set of expertise.

Adding ESG dashboards and ESG data streams to a fundamental analyst arsenal of analytical tools does not fully compensate for the additional time required for that analyst to manage ESG factors. Failure to build the human resource capacity required to manage that added responsibility is likely to degrade the quality of the resulting output both on the fundamental and ESG side of the equation.