While more institutional investors are factoring sustainability in their investment decisions, there is little agreement about what sustainability means, or how to measure it.
Interviews with three sustainable investment professionals—all graduates of Columbia University’s Sustainability Management graduate program—indicate a growing demand for investing that accounts for sustainability performance, but also obstacles to discerning the best investments.
“How sustainability is defined varies from investor to investor,” said Carolyn Roose, an associate at Sustainable Insight Capital Management. The definition was once simpler as socially minded investors excluded certain industries, say tobacco producers, from their portfolios. Now, according to Roose, what might be a sustainable investment for one of her clients may not qualify as sustainable for another. The disparate definitions of sustainability are changing what qualifies as a sustainable investment.
“Ours is a best-in-class approach,” said Kevin Lehman, an analyst at Breckinridge Capital Advisors, of this new way of defining sustainable investing. “We take an agnostic view on industry sectors, as we can allocate capital to strong sustainability performers and avoid the weakest.” The most sustainable investment, according to this view, is the firm that best manages its longer-term sustainability risks and opportunities and also has a solid financial base.
A growing number of information providers is competing to help investors identify the investments that best meet their definitions of sustainability. As a result, sustainability metrics, reporting frameworks, ratings and grading systems are proliferating. A white paper (PDF) published in 2014 by Steven Cohen and others at Columbia University’s Earth Institute reported 557 environmental, social and governance indicators. In essence, the providers of this information seek to impose sustainability standards in a field that operates largely outside of government oversight.
“The biggest issue is this data,” said Julian Seelan, a manager in the wealth and asset management advisory practice of EY. That’s because the way that firms quantify their environmental impacts varies, as do the sustainability impacts of firms in different industries.
Reporting annual greenhouse gas emissions, a common sustainability metric, exemplifies these problems. Firms report the quantity of their emissions in absolute terms or as an efficiency measure, but, in either case, the data is difficult to evaluate without any national or international marker of acceptable emissions levels. The types of emitting sources that firms include in their accounting may also vary from one firm to another, making it difficult to compare firms. Comparisons are especially difficult across industries, because the environmental impacts associated with the operations of each industry can be different.
“We perform quantitative ESG research, but a qualitative analysis is critical when there is not always a direct link between ESG data and investment risks,” said Lehman, referring to the environmental, social and governance data that are used to quantify sustainability.
In the absence of standardized metrics, analysts are forging their own techniques for identifying sustainable investments. Often published data and sustainability ratings are the starting point for a more comprehensive analysis, which also includes traditional financial information and qualitative sustainability data, which is based on knowledge of the firm itself, the industry as a whole and sustainability issues.
The Earth Institute has sought to enhance the ability of investors and financial analysts to make these evaluations by offering a Certification of Professional Achievement in Sustainable Finance as part of the Sustainability Management Program. The certification program prepares students to apply the fundamentals of both corporate sustainability and finance.
Over the last five years, Lehman said, Breckinridge has reduced its reliance on published sustainability ratings and focuses more on its own internal analysis of a company’s sustainability performance.
Sustainable Insight Capital, where Roose works, uses statistical analysis to determine the connection between each of the company’s ratings on the environment, social issues and governance and its stock price. Of these sustainability indicators, governance—shorthand for good business management—has been the easiest for financial analysts to understand and integrate in their analyses. “But we are seeing environment and social scores become more important,” Roose said.
Seelan, who works with asset managers to make sense of sustainability data, said that the priorities of his clients shape the analysis. “You have to identify the most meaningful metrics to an asset manager, evaluating the entire portfolio of investments,” he said.
Still, according to all three analysts, sustainable investing needed better and consistent ways to measure sustainability. “The standardization of metrics would be the holy grail for our ESG research,” Lehman said.