Ben Ashwell explores efforts on the sell side to integrate ESG into fundamental research, and asks how this information is differentiated from ESG data
The role of an equity analyst is to parse vast quantities of structured and unstructured information into simple, easy-to-follow research reports that provide investment advice to clients. As asset managers face greater pressure to disclose the ESG risks their portfolios are exposed to, sell-side analysts face similar pressure to assist their clients by acting as detectives, rooting out potential undiscovered ESG risks their clients – and their clients’ clients – may be exposed to.
Whether they make good detectives depends on who you ask. Long-tenured, highly experienced sell-side analysts will know their sector better than most and will, therefore, have been factoring in ESG risks as material risks for years, if not decades.
At least that’s the party line from many on the sell side. Sometimes this research has been explicit and sometimes people have needed to read between the lines. In this interpretation, the analysts’ learning curve is short; they had to understand the taxonomy of ESG in order to use the correct words, phrases and labels in their research.
But not everyone sees it this way. IR Magazine spoke to several IR professionals at companies that are broadly considered to have done a good job integrating ESG into their equity story, and they describe working hard to ensure that their consideration of ESG risk and reward is priced into their analysts’ research. Their reading is not that equity analysts simply need to show their working, but that they have more work to do to broaden their analysis – especially in light of the large number of ESG raters and rankers out there.
In fairness, this isn’t representative reporting: companies that lead the way on ESG will likely feel their ESG story could be better understood. By the same token, sell-side analysts who lead their profession on ESG integration will likely feel the public companies they cover could be doing more to integrate material ESG factors into their financial reporting.
Regardless, there is a concerted effort on the sell side to fully integrate material ESG factors into research and to standardize the taxonomy – as there is on the buy side, and among issuers, raters and rankers.
Promotions, hires and expanded roles One approach being favored is to hire or promote individuals to create ESG research teams that can work across different asset classes to advise, educate and consult the sector specialists. Some interviewees liken these groups to internal think tanks, while others say the creation of these teams mirrors the formation of responsible investment teams on the buy side in recent years.
This is the approach Barclays took when it hired Marie Freier as its managing director and global head of cross-asset ESG research in January 2021. Freier has spent the bulk of her career at Sanford Bernstein, the sell-side arm of Alliance Bernstein, most recently as its global head of ESG.
She says she was drawn to the Barclays role because of the scope she has to build a team of ESG experts who can work with Barclays’ equity and credit analysts, and to anticipate regulatory and market changes coming down the road.
Influencing tenured equity analysts is sensitive work that requires a deft understanding of soft power. ‘Part of why this role is so difficult is that you’re telling very experienced, intelligent folk who have been doing this for a very long time that they haven't been factoring in crucial elements of ESG,’ Freier says. ‘Invariably, there’s an Aha! moment where they realize we’re talking about topics they’re familiar with. We need to challenge ourselves to analyze non-financial and intangible topics, even though they don’t fit as neatly into financial analysts’ way of working. It can be quite a lot of effort to get them comfortable with new data sources, but it’s a natural extension of what they do, and what they do well.’
Part of Freier’s job is to co-ordinate the ESG research Barclays has been producing across different parts of the business, including the sustainability team, the quant team and the fundamental analysts. This is largely the same for her counterpart, Anita McBain, at Citi Research. McBain was appointed as head of EMEA ESG research in September 2020 and also brings recent experience of ESG integration on the buy side, having previously served as head of responsible investment and ESG at M&G Investments.
‘My mandate here is to raise awareness for ESG, to lead on integration of ESG, to evidence that integration and to demonstrate its outcomes,’ McBain says. ‘I believe it’s really important to be seen as an enabler. I’m there to support my colleagues and work side by side with them. A lot of our analysts have 25 years of deep sector expertise and in many cases they’ve been focused on ESG integration already. I’m working to formalize that into a structure.’
A collaborative process This speaks to an iterative and collaborative process in which the equity analysts are active participants – and rightly so. Definitions of ESG materiality have evolved rapidly in recent years, helped in no small part by SASB standards, and analysts are expertly placed to understand how a new data point could affect a company’s valuation. For instance, Glassdoor data on employee satisfaction, workplace culture and compensation may hold more weight in a sector where competition for skilled talent is fierce – such as technology and SaaS – than in sectors with large, low-skilled workforces.
This collaboration is central to Bank of America Merrill Lynch’s approach, says Savita Subramanian, head of ESG research and US equity and quantitative strategy. About five years ago, the quantitative team started back-testing the 500 data points that contribute to MSCI’s ratings system to understand the correlation between those data points and company performance. After analyzing the results on a sector basis in the US, Subramanian also conducted a global sector analysis.
It was at this point that she found ‘the devil is in the detail,’ she says. ‘You can’t determine what’s most important at a market level without understanding the industry or region. We took our back-tests to our bank analysts, who are amazing and live and breathe these companies. They were able to improve the analysis.’
Ultimately, this gave the bank a framework for how to think about ESG issues by sector and region, which is now used by the fundamental analysts. ‘Five years ago when we were talking about it, there were some analysts who were really engaged on this and others who weren’t so sure – they felt it was more of a loosey-goosey ethical discussion,’ Subramanian says. ‘Now we have this framework, built on what we found in our back-testing.’
The investor angle Of course, one of the reasons the sell side is taking strides to integrate ESG issues into its fundamental research is demand from investors. Many of these investors subscribe to third-party ESG data providers – such as MSCI, Sustainalytics and ISS Corporate Solutions – that investor relations teams often grumble about.
These data providers have intrinsic cap size and sector biases, only focus on past performance, reward disclosure rather than performance and are labor-intensive to engage with. At least that’s what IR professionals say over and over at IR Magazine Forums. But these data providers also do exactly what they say on the tin: they provide quantitative data for arguably the biggest and most rapidly evolving investment theme of the last five years.
This underscores the approach Raymond James is taking toward ESG integration, according to Tavis McCourt, managing director and institutional equity strategist at the firm. ‘ESG is inherently qualitative, but ratings firms aim to make it quantitative,’ he says. ‘Our clients were asking for more help with ESG. We service all institutional clients, but we’re probably best known for small and mid-cap coverage.
‘Those clients are being asked about ESG decision-making when they respond to requests for proposal for institutional money management, and one of the pain points is that these data providers have historically had biases related to cap sizes.’
McCourt – along with his colleague Leslie Vandegrift, associate strategist within the institutional equity strategy department – worked with Raymond James’ fundamental analysts to get a picture of what they could provide. They now produce a monthly research report in which they summarize the latest developments from the standards and framework providers, include their top 25 ESG stock picks and highlight perspectives from fundamental analysts about ‘themes and concerns with the data that’s out there,’ McCourt says.
On top of this, they periodically publish thematic papers on meaningful ESG trends, with the most recent paper focused on how Covid-19 brought social issues to the fore.
Alongside execution and reputation, differentiation is one of the key selling points for any professional services firm, so why should investors care about investment banks writing more robust ESG research when they’re already subscribed to data providers?
Several interviewees for this article came back to the analogy of not being able to see the wood for the trees when discussing data providers.
‘The scores have a very important role to play, but I’m somewhat concerned by how the industry is coming to rely on them as the absolute truth,’ Freier says. ‘I worry a little bit that we’re losing sight of why we’re collecting data. This is about incremental insight and knowing which questions you are trying to answer in the first place – and that’s why fundamental analysts are so important. If they know the business intimately and also bring to bear their expertise on ESG questions, that’s when the magic starts to happen.’
McBain goes further: ‘All of the current ESG data providers supply static and backward-looking data. What investors want to see is dynamic and forward-looking data. The world has fundamentally changed in the last 20 years – we’re seeing once-in-100-year events happening every 10 years – and analysts today need to be able to understand how well a company has understood these risks.’
A more dynamic ESG story If the sell side continues to invest in building out ESG teams that work to integrate material themes into fundamental research, it’s fair to assume that greater scrutiny will be placed at the feet of IR teams.
But this isn’t necessarily a bad thing. A number of investor relations professionals tell IR Magazine they would welcome a more nuanced conversation with their covering analysts – who know their business inside out – about why they do or don’t report on a specific ESG issue.
‘That’s where this can get really interesting,’ says Subramanian. ‘We can write about two companies where one publishes glossy reports and trades at a premium, while the other doesn’t disclose but may have more alpha.
‘If you can identify a company that is planting lots of trees but missing earnings targets, that’s where analysts can have a fair amount of dialogue.’
There’s a broad and ongoing debate about whether ESG topics will become a regular part of the earnings call, rather than being sporadically added to the script during a crisis.
The interviewees for this article are divided on whether fundamental analysts will ask more ESG questions on the earnings call if they’re more attuned to ESG topics, noting that most ESG risks have a mid-to-long-term time horizon, and earnings calls tend to focus on short-term results.
But there is consensus from interviewees that, starting now, sell-side analysts are going to expect IR teams and management to be versed in the ESG risks and opportunities that contribute to their equity story.
That means they shouldn’t refer the analyst to the sustainability, HR or governance team. Issuers can also expect ESG integration to be table stakes for certain conference participation in the not-too-distant-future, according to Subramanian.
Ultimately, issuers, the buy side and the sell side are all on a journey to identify, understand and integrate ESG research into their processes. Some are further down the line than others. Some are good at looking like they’re further down the line than others.
But all parties will benefit from engaged and informed conversations on a frequent basis – as is the case with the fundamentals of a business. And, according to the interviewees for this feature, that’s what the future holds.
