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Thought piece: SRI research is not broken
A response to Professor Jem Bendell’s article on 9 flaws in ESG ratings and analysis.
In April, Professor Jem Bendell wrote an article in Responsible Investor outlining 9 flaws in ESG analysis and ratings Link and highlighting five fixes. I disagree with almost all of the flaws that he identifies and believe that the fixes he proposes will drive SRI into a niche.
In a second article, I will outline how any problems that do exist in SRI research are plumbing problems that require practical solutions by the industry rather than policy flaws requiring external intervention. To back my conviction in these arguments, I’m going to put SRI-CONNECT’s July marketing budget behind a bar in London for any SRI analyst or portfolio manager who wants to join Professor Bendell and me on 28th July to discuss these points: Register here
Professor Bendell’s full paper can be found in the Journal of Corporate Citizenship: Link
Flaw 1: Over-reliance on companies for information
Professor Bendell argues that SRI analysts rely overly on information presented by companies. This concern assumes SRI analysts are not intelligently sceptical about the information that they receive from companies. They are!
Flaw 2: Focus on processes rather than outcomes
Professor Bendell believes that SRI analysts focus too much on the processes by which companies achieve sustainability results rather than on the results themselves.
However, past performance data is widely used in SRI research and fulfils an important role. But this has two limitations:
• First, it nigh-on impossible to establish useful and reliable comparators.
• Secondly, past performance is typically ‘priced in’ very quickly and therefore only useful for investors with very aggressive trading strategies.
In order to understand longer-term future performance, SRI analysts have to scrutinise the policies and processes that will deliver this.
Flaw 3: Downside risk focus
I agree entirely that analysis of upside opportunity should be, but is not yet, an equal part of SRI analysis – not least because ‘top-line growth’ is more easily communicable than ‘bottom-line’ or ‘risk-based’ investment arguments. Interestingly much of the upside opportunity that he refers to comes from a company’s ‘economic’ contribution – the missing ‘E’ in the flawed ‘ESG’ initialism.
Flaw 4: Unsophisticated research frameworks
Professor Bendell argues that SRI research frameworks are less sophisticated than CSR practices. This is true, but it is stating the obvious and inevitable. Also, mainstream investment analysts’ models are also much less sophisticated than the internal business plans of the companies they are assessing. To expect SRI analysts to match corporate practitioners’ levels of information and understanding or that of specialist policy or campaign organisations is to misunderstand the role of the SRI analyst
• It is not the job of an SRI analyst to know more about the companies that they analyse than the companies themselves.
• Nor is it the SRI analyst’s job to be thought-leaders on best sustainability practice within a given industry
• Instead it is an analyst’s job to interpret, from the information that they can source (at reasonable cost) how a company’s share price will perform.
Professor Bendell is certainly right, however, to highlight that it is dangerous to translate sustainability information into numbers in a way that gives a spurious appearance of being investment-relevant. There is nothing wrong with unsophisticated analysis; there is a lot wrong with unsophisticated analysis that masquerades as (financially) sophisticated analysis.
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