NextBillion - An Initiative of the William Davidson Institute at the University of Michigan

Friday, September 8, 2017

Environmental, social and governance (ESG) research and ratings continue to gain momentum among mainstream asset owners and managers. The big investment research and index providers, such as Morningstar and S&P, have taken stakes in ESG companies or acquired them outright. The recent mergers and acquisitions all point to the fact that ESG is important to the investment process, and when used properly can identify both risk and opportunity.

While the sweeping uptake of ESG research and ratings within the investment industry is a welcome evolution, many recent adopters use a check-the-box approach. More investors, both individual and institutional, demand that their investments achieve both financial and ethical returns. To cater to this increasing demand, managers are touting the fact that ESG and other sustainability criteria are, at the very least, considered in the investment process.

But solely relying on ESG data and ratings is incomplete. Investors that have used ESG long before it became a buzzword in the investment industry know that ESG analysis is a complement to — not a substitute for — fundamental analysis. ESG analysis should not be easy. It is a discipline rooted in the fact that making an investment decision is about more than analyzing numbers; it is about understanding how non-financial factors hinder or help company performance.