Measuring the Financial Impact of ESG Factors on Investments

The Defined Contribution Institutional Investment Association (DCIIA) hosted a panel about examining the financial impacts of environmental, social and governance (ESG) factors on investments during its Academic Forum.

One of the key themes throughout the session was the importance of measuring the materiality of each factor. Materiality importance depends on location and strategy, said Shaheen Contractor, a research analyst on the environmental, social and governance team at Bloomberg Intelligence.

She said looking at the performance of ESG investing in the United States compared with its showing in Europe is a good example of how such investments can differ. While ESG investments have underperformed in the U.S. since the economic recovery period in the third quarter of this year, the funds have largely outperformed in the European Union (EU). Therefore, looking at short-term measures is not an adequate outlook, she said. “ESG is a long-term performance measure. … It’s important to measure those nuances—that it’s so different by location and strategy,” she added.

David Wood, director of the Initiative for Responsible Investment (IRI) at the Hauser Institute for Civil Society at the Harvard Kennedy School of Government, echoed that thought, noting that ESG investors need a set of comparable information across themes and portfolios.

Contractor recommended looking beyond company reporting to understand each factor behind “E,” “S” and “G.” “Understanding the data and metrics for the ESG standard, try to understand more forward-looking targets or measures of performance,” she said.

Investors must also take into account changes that have occurred throughout 2020. Wood noted that the divide between economic and systemic inequality and responsible investing is closing somewhat, as more companies are being held accountable for their diversity and inclusion efforts. A history of inequality can strain performance levels, he said. “With responsible investing, whether or not people are engaging policy discussion, there is a focus on sustainable social systems,” he said.

The final rule on ESG investing implemented by the Department of Labor (DOL) has also brought challenges to responsible investing, and, more specifically, on how to interpret such investments. Christopher Geczy, an academic director for the Jacobs Levy Equity Management Center for Quantitative Financial Research at the Wharton School, explained that it’s important to document practices when analyzing and selecting responsible investments, and to use third-party professionals to assist in that effort to comply with the DOL’s final ruling.

“The standards are higher on documentation and decisionmaking,” he said. “There are a handful of critical questions, but the baseline notion of comparative analytics will stay there. Document as always and have the analysis done.”