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Modeling future financial outcomes - connecting the dots with ESG data

Updated: Nov 26, 2023

Increased stakeholder scrutiny on ESG investing practices over the past couple of years – from regulators to the anti-ESG camp – makes clear that investors have to level up their ESG analytic capabilities if they are to avoid legal penalties and reputational damage, and also to win mandates.

Transparency is obviously critical, but when it comes to ESG integration strategies, it’s also an investors’ fiduciary responsibility to assess the likely impact of sustainability risks on financial returns in a systematic way.

While there is no shortage of academic and industry research on the link between sustainability and financial performance, for investment professionals, including responsible investment (RI) teams that support portfolio managers on ESG issues, translating this to day-to-day practice can be a challenge. How can investors and RI teams utilize ESG data analysis in a way that makes more practical sense in the investment decision-making process?

Further, for fundamental investors, assessing business strategy, operations and backwards-looking ESG indicators are only one part of the evaluation. How can they further demonstrate, using the myriad of existing data sets in front of them, that sustainability impacts future firm-level value creation (or value destruction) in a transparent way?


Finding diversity in common


To help address these issues, PortageBay’s data scientists performed a large-scale quantitative analysis to identify the mix of E/S/G factors and alternative data that contribute to improving financial performance, such as ROE, ROA, ROIC and margins.


 
One of the key findings is that women representation and diversity factors are among the most common factors across sectors that contribute to value creation.
 

This is significant given that social factors, particularly those around human capital and diversity and inclusion are a frequent target of the anti-ESG movement. Indeed, the 2023 AGM season thus far has seen a 60% jump in anti-ESG proposals, most of which target the topic of diversity.[1]

Furthermore, diversity in the workforce translates to improved financial performance in most sectors. This aligns with the increased investor engagement on companies to address diversity, equity, and inclusion (DEI) firmwide, not just in board composition. Empirical evidence supports that diversity is generally positive for its better social and financial outcomes.

As the data gets better and evolves, specifically around diversity beyond gender, we may see a shift in those influencing factors. Forecasting financial outcomes tied to sustainability factors in the future will likely look different than it does today, and investors need to be tuned into the dynamism of this space in order to extract value.

To address the concerns of an investor’s fiduciary responsibility; to demonstrate to clients and regulators that ESG data analysis is sufficiently robust; and to answer the “so what?” question RI teams often need to answer to better connect with their investment counterparts, the link between sustainability and financial factors must be tangible. PortageBays’ S2F model shows these linkages and how ESG factors impact future financial performance.

PortageBay’s Sustainability-to-Financial (S2F) models forecast financial performance from ESG data. To learn more about S2F, please contact info@portageb.com.





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