Our meetings over the last couple of weeks confirm several developments within the ESG investing world, all of which have been the focuses of our prior work. The first is a very significant step up in ESG oversight among most fund managers, with dedicated ESG teams at many companies scrutinizing sustainability reports and other releases, looking for red flags either from inconsistencies in reporting or from departures from the fund managers standards. Second, there remains a lack of real empirical analysis that allows for accurate comparisons between companies and this stems from the fuzzy reporting frameworks that we have today and the lack of clear and actionable guidance from regulators. As we have discussed several times, the huge inflows into ESG funds and the proportion of overall funds market that now has a “social impact” overlay could lead to real disruptions and some rapid valuation changes if and when the regulators provide tighter guidance on both corporate reporting and fund labeling.
Thirdly, on the E side of ESG, as more industrial companies are reporting emissions – scope 1 and 2 broadly and scope 3 for the more ambitious – it is becoming a point of focus for investors because it is measurable data and there is an assumption that each company is using the same or similar methodology. This will almost inevitably lead to more questions on how the footprint can be reduced and a call for more clarity than the broad statements such as “ we will lower our CO2 equivalent footprint by 20% by 2030”. Investors are likely to call for more ambitious targets, but they are also likely to want project by project clarity – more numbers around how the broad goal can be achieved.
In the meantime, the flow of funds into the ESG space can cover a lot of sins. Warren Buffet’s challenges are real, not because he is not picking great companies, but because the increase in funds chasing a smaller defined universe of stocks could raise multiples for the “cleaner” names even further – his holding could outperform on an earnings basis but under-perform because of relative multiple contractions. Recent China data shows the same phenomenon – more funds chasing a smaller universe so the ESG universe outperforms, in this case moving up in a down market. See more in today's ESG & Climate report.