#Sustainability, #Impact, #Data
About Patrick Wood Uribe
Before joining Util, Patrick was Head of Business Development and Academic Research at Kensho, the leading provider of AI to sophisticated financial institutions. In 2018, Kensho was acquired by S&P in the world's largest AI acquisition to date.
Util’s unique methodology provides investors evidence-based sustainability data at scale. Interview with its CEO, Patrick Wood Uribe.
Can you describe the recent evolution of investors’ behavior in regard to ESG?
I’d say it’s been a perfect convergence of factors. I first became interested in responsible investing at least a decade ago, partly because the financial crisis revealed the awful consequences of irresponsible choices.
At that time, after the financial crisis, interest in ESG was already increasing, and I was among a growing number of investors who realised that financial markets were not disconnected from their lives, values, and choices. In regular consumer behaviour, people were already starting to care if the products and brands they used every day were actually reflecting their values, and we started to see this applying to finance as well.
If I want to know Tesla’s P/E ratio, it takes me seconds to find it on my phone. Finding equivalent actionable information on a company’s impact could take me hours, if I ever find it at all.
Given these conditions, ESG would have continued to grow anyway (following that inevitable trend), but the past year has combined two drastic elements. Firstly, the pandemic brought out the incredible importance of recognising our collective humanity, and with it, the idea of living our values, including through our investments. Many investors were encouraged by this impulse to move more assets into ESG. But a second element was the sudden drop in our normal oil-consuming activities like commuting and travel, and as a result almost any fund with a basic exclusion of some fossil fuels would outperform the broad market index.
That means that even very crude ESG strategies produced returns recently, but a closer look shows the story is more complicated. Is money flowing where it matters? Is it going into indexes that are labeled as ESG but still contain a good number of traditional oil and energy companies? Or is the money going to companies that are actually working on a measurable transition towards renewable energy? And where are the best opportunities? Is it better to invest in a giant company taking small steps, or a tiny company making the biggest strides it can? BP, for example, generates less than 1% of its revenues from biofuels; but it’s also about 100 times the size of Canadian Solar or Renewable Energy Group. Among vehicle companies, does it make sense to buy more Tesla (at an absurd PE ratio of 938), or look to traditional car companies starting to add electric vehicles to their lineup? How do we choose? Or, more importantly, how do we give every investor the information they need to find value consistent with their values?
That is a complex situation, but what should we do about it?
These questions show both the scale of these challenges, and why it’s critically important to have better data about the impact of companies. The idea is that using better data, we can guide capital towards greater impact without sacrificing returns. This is exactly why we gather and structure our data the way we do at Util: we want to understand not only the positive impacts of companies through the products they sell, but the negative consequences that need to be recognised and managed as well. We also want to do it in a framework that is global, wide-ranging in the issues it covers, and goal-focused, so we use the UN Sustainable Development Goals to contextualise our output. A typical visualisation of Util’s data looks like this:
There is one segment for each of the 17 SDGs, and the green and red blocks represent the percentage of revenue that aligns positively and negatively for the company, or companies in the portfolio. Some companies sell products that are positive for one SDG but negative for another, and we capture this using our percentages. (Our data goes into depth for all listed companies, and easily aggregates to the portfolio level.) The critical goal for us is to realistically capture the many impacts of products on the world, not just one dimension.
It’s also particularly urgent to answer these various questions because ESG is expected to grow considerably, by some accounts doubling in the next 4 years. Without good data, how will we understand and manage the real impact of investments? How will we avoid wasting capital on greenwashed products?
Between two similar companies, despite quite similar profiles in terms of their business and returns, we see very different impacts on the world from their products: say both Company X and Company Y sell cleaning products, skin care, and hair care products, for instance, but Company Y also has dairy, food, and coffee businesses, adding both positive and negative impacts. Set against the SDGs, the latter has a greater positive impact on hunger and health (SDGs 2 and 3), but also more negative impacts on climate, water, and wildlife (especially SDGs 13, 6, and 15):
The two companies have similar return profiles, but if you care about poverty, hunger, and education, Company Y will guide your investment towards more positive impact in those areas than Company X. You get the same return, but you also get to choose the impact you want to support.
Another way we can help is looking at companies that are transforming. I’ll mention one quick example, a power company. Here’s what their Util impact chart looked like in 2016, when most of their business relied on traditional energy generation:
There are some positives from their growing renewable business, but there are still considerable negative impacts on the left of the chart. Here is how the company looks in the most recent chart, now that most of its business comes from wind and renewable power:
More positives across the board, and dramatically reduced negatives, too. And since it’s a change in how the company generates its revenues, it’s a transformation at the core of the business. The process of transitioning to renewable energy sources is a massive undertaking, in which it is crucial to separate vague promises from meaningful change, and our data can help.
What about ESG funds?
There’s a bewildering array of products out there. What’s the difference between an ETF that’s “ESG Screened” compared to “ESG Aware”? What about the difference between “ESG Screened” and “Sustainability Screened”? Why do several ETFs labelled this way contain not just one, but many obviously polluting companies? Below are two radial charts for two prominent ESG-labelled ETFs:
The key thing for both of these is that while there are green segments (denoting positive revenue alignment), all of the key environmental SDGs (12, 13, 14, 15, on the left side of the circle, and SDG 6 at about 4 o’clock) have more negative alignment than positive. That’s important in two ways: first, it means that overall, the products sold by the companies in both of these ESG ETFs are actually doing more harm than good, today, for those SDGs. Secondly, and more crucially, it means that every year this proportion persists without transformative changes in the underlying businesses, those negatively aligned revenues will continue to accumulate – in spite of the ESG label – taking all of us further from the environmental outcomes the world needs.
How is ESG changing capital allocation?
We are already seeing some significant impacts on capital allocation: 30% of European funds are now labelled as ESG, and that’s projected to grow to almost 60% by 2025. These numbers should be approached with some caution, though, since there is widespread disagreement and inconsistency in ESG data — what counts as ESG in the first place, and what relative importance each area or issue assumes.
ESG in its current form keeps up with investors’ needs about as well as Hippocrates’ four humours keep up with modern medicine: yes, they are indicative and sometimes helpful, but we have a long way to go. Thankfully the tide has turned, and improvements will follow.
What’s important at the moment is that this dramatic increase in demand for ESG highlights an important shortcoming in traditional information: investors need new dimensions of data because financial data alone isn’t enough to identify valuable opportunities and isn’t the fullest representation of companies or their future potential. If I want to know Tesla’s P/E ratio it takes me seconds to find it on my phone. Finding equivalent actionable information on a company’s impact could take me hours, if I ever find it at all.
The demand for ESG also represents what I believe is a fundamental, secular transformation of capital markets towards valuing companies using non-financial goals and principles on an almost equal footing with financial data. It’s a drastic change, moving away from just preserving capital or maximizing gains, and is probably the most important shift for at least this generation if not the next one or two as well. The long-standing principles of capital preservation and maximising gains will no longer be the only guiding factors in capital allocation decisions. In fact, in the next few years, these non-financial metrics will change the very conception of ‘shareholder value’ that guides how companies are managed.
In this sense, the impacts of ESG — or more accurately the better thing that ESG will become — are far-reaching, deep, and lasting: regulation is already changing, the nature of competition (what is a successful financial product) in capital markets will change, the gravitational pull of what makes companies ‘attractive’ as investments will change. And of course, in the best outcome, the world will change for the better.
What is your foresight in new ESG compliant investment opportunities?
As regulation mandates increasing disclosure (as to how investments comply with ESG criteria), we’ll see two things happening at the same time.
The current interest and growth will continue, but with some rebalancing as the most alpha-focused investors move away from ESG to capture non-ESG performance gains.
There will be more bumps in the road as disclosures reveal the extent to which ESG criteria are strictly applied (as they are often only loosely applied today). Some funds will need to be re-categorised, some will close, and those with the best data and credentials will attract flows.
What will also happen, though, is that technology will play a more important part in allowing us to understand the nature of non-financial impact. The technology we use at Util, for instance, is designed to process more information than any team of humans could manage, so we can surface better evidence and deeper data on which investors can base their decisions. Technologies like ours will not only increase the information value of all kinds of data, but will also make sure that it can be transmitted, understood, and implemented.