Authors: Alex Kramm, Head of US Exchanges and Business Services Research, UBS Global Research
Paul Winter, Head of Quantitative Research, UBS Global Research
Amanda Jorgensen, Quantitative Research, UBS Global Research
Arsh Tandon, US Exchanges and Business Services Research, UBS Global Research
The major index providers and market data firms are racing to build or buy sustainability offerings. Demand for sustainability data could drive the size of the related data and services market to more than USD 5 billion in the next five years. Sifting signal from noise will be critical for shaping better portfolios
Investment mandates that consider environmental, social and governance (ESG) factors have grown rapidly in recent years, with a further acceleration occurring amid the COVID-19 pandemic. Our work shows that some ESG factors have a significant impact on performance, with carbon considerations particularly present in our analyses. We also expect that investors will increase ESG considerations in their processes, particularly as regulations advance and reporting standards improve, which, in turn, could make performance attribution to ESG easier to assess. Ultimately, greater demand for ESG will spur a large industry of innovative data and services providers, one that we believe could be as large as USD 5 billion in annual revenues five years from now
Significant ESG sub-scores
What are the key factors that will affect further ESG adoption?
We believe greater demand for ESG investing will require further adoption of ESG data and analytics, including ESG ratings and scores from information services providers. That said, there are various key factors that could, in our view, accelerate or inhibit this growth. As part of UBS Evidence Lab’s Market Thinking Game, which asked institutional investors to gauge the consensus outlook for spending on ESG data over the next five years, respondents were also asked to rank the key issues regarding the outlook from most to least important.
Perhaps unsurprisingly and as also shown in figure 16 in our Perspective 10, “Performance of ESG investing” was the highest ranked issue on a weighted basis and had the largest number of participants select it as the most important issue.
“Lack of reporting standards” and “Further ESG regulations” followed in importance, in weighted terms, and we believe these two factors will play an important role in the adoption of ESG investing moving forward. To that end, we are closely monitoring the development of ESG regulations across the globe (particularly in the US after the elections there), which could enhance corporate and investor reporting standards, and ultimately serve as catalysts for an even greater acceleration in ESG investing.
Do ESG considerations enhance investing performance?
We analyzed whether component sub-scores within ESG ratings drive returns, utilizing ratings from Sustainalytics. Through our regression analyses for US and European equities, we found that several environmental, social, and governance sub-scores showed a statistically significant relationship to returns. That said, a better sub-score across these components did not always positively affect performance, which indicates that the overall effect of ESG ratings on performance remains mixed. Furthermore, we note that carbon scores were consistently present in our analysis, which indicates that these scores are very important.
Please note that a limitation to our analysis is the fact that ESG ratings and scores themselves vary across various providers, given differing methodologies.
ESG rating correlations across six ratings providers
ESG remains in an innovation phase
Overall, although the contribution of ESG factors to performance remains subject to debate, we believe the development of ESG data and analytics remains in an innovation phase, and the quality of the data offerings continues to improve. In our view, innovation should be assisted by greater regulation and better reporting standards; as this takes place, we believe the relationship between ESG factors and performance may be easier to assess, which could be supportive of investor adoption. As mentioned above, demand for ESG and continued innovation could drive the size of the related data and services market to more than USD 5 billion in the next five years.