By Robert Fagin
ESG issues are driving change across the industry. The sell side, buy side and investor relations specialists are responding in kind.
The sell side is increasingly focused on ESG issues as part of its research process. This is being driven by its core customer base: the buy side has dramatically expanded its ESG and sustainability-related offerings. During 2020, flows into sustainable open-end funds and ETFs available to US investors reached $51.1 bn, versus $21.4 bn in 2019, according to Morningstar. That $51.1 bn figure represents 24 percent of overall flows into US stock and bond funds for the year.
A remarkable 50.5 percent of fund flows into European funds in 2020 focused on ESG. Institutional investors have a definitive mandate. EY’s 2020 Global Alternative Fund Survey finds that the percentage of professional investors required to invest in ESG products increased to 26 percent in 2020 from 14 percent in 2019, with that figure expected to nearly double again in the next two years. It is telling that of the more than 5 mn Cowen research reports read by our clients in the last 12 months, our ESG Best Ideas publication was among the top three.
A demographic shift is driving the increased focus on ESG and sustainability. The next generation of investors is characterized in part by an increased awareness of, and concern about, ESG issues. A survey conducted by Fidelity in January 2020, for example, finds that two thirds of retail customers believe social impact is important to their investment decisions. To some degree, ESG and sustainable investing are also being driven by an evolving view of risk, wherein fund managers see ESG frameworks as an important input in their broader portfolio construction.
Finally, regulatory activity is playing a role. In the EU, three supervisory authorities recently published their final report regarding sustainability-related disclosures for financial services companies, known as the SFDR Level 2 Rules. In the US, the SEC has addressed issues of ESG disclosure, and recently dedicated a web page to the subject, emphasizing its increasing focus.
In early March 2021 Cowen announced a partnership with Truvalue Labs, a FactSet company, to establish a uniform ESG score for the majority of companies we cover. We became the first major Wall Street firm to commit to putting such scores on the front page of our company research reports. ESG scores alone do not add immediate value, but they are helpful in two respects.
First, they provide a common framework for analysts to discuss companies, and place relative ESG performance in context. Second, they are a strong starting point for deeper research, particularly as analysts can probe the underlying score inputs for insight.
The Cowen way At Cowen, we believe layering an ESG focus on top of fundamental research is where the sell side can add the most value versus stand-alone ESG ratings or data products. We want all of our analysts ‘speaking’ ESG and incorporating related factors into their fundamental research product. Our analysts have authored company and industry-specific reports focused on issues such as executive compensation, corporate governance and carbon footprints.
They also regularly host conference calls and fireside chats with the CEOs and heads of ESG initiatives at major corporations such as Walmart, JetBlue, Gap and United Airlines to discuss ESG developments. This is all in addition to Cowen’s ESG and sustainability-specific research products, such as our annual ESG Best Ideas report, ESG Primer and our coverage of the full spectrum of energy transition/alternative energy stocks.
As a consequence of the buy-side and sell-side focus on ESG, corporate IR and PR efforts have similarly begun to retool to prioritize an emphasis on this area. Much as corporations have had to navigate relationships with external credit ratings agencies, they now find themselves interacting with a variety of ESG-focused ratings agencies. Unfortunately, there are dozens of ESG ratings and scoring systems on the market and, because of disparate inputs and methodologies, scores from one often do not correlate with scores from another. For this reason, we have counseled companies to focus on three strategies.
1. Proactively engage the buy side and sell side Because ESG and sustainability are of increasing importance to investors, IR professionals will be on the front lines of communicating corporate strategy and posture. It is critical to build relationships with both fundamental analysts and ESG analysts. Be responsive regarding ESG issues, and make corporate heads of ESG and sustainability accessible to the investment community as needed. Strategize about ESG outreach the same way you would about non-deal roadshows. Numerous companies, for example, have hosted ESG days or sustainability forums, and many have begun to include an ESG segment in investor days.
2. Be informative and honest Many companies have begun to make quarterly or annual ESG metrics available to stakeholders. Just as important is to ensure a company’s ESG pathway is clearly articulated, and to provide specific goals and mileposts that investors can hold managements to. Ensure that disclosures are detailed, straightforward, unbiased and meaningful – relevant and representative of the industry. Note that the SEC has signaled that some degree of ESG data standards and uniformity is likely over time. We imagine that, over the longer term, it is quite possible that ESG reporting standards will emerge – just as Gaap reporting requirements emerged in the 1930s – and that ESG data audits will become commonplace.
3. Integrate ESG into corporate messaging ESG and sustainability efforts should be incorporated into companies’ dialogue with investors, just as corporate strategy and earnings are.
Robert Fagin is director of research at Cowen and Company
Cowen is a diversified financial services firm offering investment banking services, equity and credit research, sales and trading, prime brokerage, global clearing, commission management services and actively managed alternative investment products. Cowen focuses on delivering value-added capabilities to our clients in order to help them outperform. Founded in 1918, the company is headquartered in New York and has offices worldwide. Cowen and Company is a member of FINRA, the NYSE and the Securities Investor Protection Corporation. Learn more at Cowen.com.
