Data revolution shaping socially responsible investing

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on March 5, 2018 - March 11, 2018.

Najmuddin (left) and Karageorgiou. Photo by Haris Hassan/The Edge

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Investors who want to integrate environmental, social and governance (ESG) principles into their strategies often run into a major hurdle — the lack of relevant information reported by companies.

However, the availability of data has increased over the years due to pressure from investors and regulators as well as the awareness of the corporations themselves of how ESG strategies can drive financial performance, says Gabriel Karageorgiou, partner at Arabesque Asset Management Ltd, who has witnessed the transformation first-hand.

“The biggest reason ESG is only starting to have a big momentum now is because data has started to become available. However, there are countries that report ESG-related data better such as Malaysia. In Japan, we can have very good governance data. In Australia, we can have quite good data in a different dimension. Data availability is not a country issue, it is a wider issue,” he says.

“However, if anything, I would say that we are living in a data revolution. If you look at the number of companies disclosing ESG-related information, there were fewer than 50 in the early 1990s. I would say that right now, there are more than 3,000 companies globally reporting on these issues. The growth has not been linear, it has been exponential, and it is only expected to keep growing in the future because there are big drivers behind it.”

The challenge of implementing ESG strategies is to identify the data points that can have material effect on the company’s performance. This is what the industry is trying to standardise, says Karageorgiou.

“We have a long way to go. The question is, what kind of data do you report? Some may say, ‘I’m reporting.’ But they are reporting things that I am not really interested in. This is where a lot of work is being done right now,” he adds.

“Globally, there are different initiatives suggesting what the material issues for each industry are. We will be in a good place when we actually have a framework with the material topics you have to ask companies to report on. Of course, the data has to be audited so we can trust the data.”

The United Nations’ Principles for Responsible Investment (PRI) was launched in 2006 to encourage investors to incorporate ESG strategies, but it did not delve into the specifics of data collection. The six principles are essentially declarations by asset managers that they will, among others, incorporate ESG issues into their decision-making processes and seek appropriate disclosure of ESG issues from their investees. Kumpulan Wang Persaraan (Diperbadankan) was the first fund in Malaysia to be a signatory of the PRI in February.

“For data, there are different standards. The Global Reporting Initiative, for example, has a big set of standards but they do not really capture the materiality aspect of it,” says Karageorgiou.

“One of the big initiatives to define materiality per industry is the Sustainability Accounting Standards Board (SASB) in the US. It is going industry by industry to identify the material non-financial topics for each industry. Now that it has this set of standards, effectively the ultimate objective is to ask companies to report on those material topics in their official communication with clients.”

The relevant information should be specific to each industry and have the potential to affect the performance of the company in the future. For example, the material topics for oil and gas companies could be how they address climate change and carbon dioxide emissions as well as their plans to adopt renewable resources in the future. For those in the financial industry, the topics could be the quality of their credit checks to prevent defaults, instead of initiatives such as their recycling efforts.

“Recycling is great and that is what you should be doing as a good citizen. But it does not really tell me a lot about your financial stability in the next 50 years,” says Karageorgiou.

 

Implementing socially responsible investing in Malaysia

Arabesque actively tracks and analyses reported data — from the companies themselves and from the media — based on the United Nations Global Compact (UNGC) and ESG principles. This covers the performance of corporations in areas such as human rights, labour issues, anti-corruption, environment and transparency of governance.

The company uses  artificial intelligence (AI) to capture and sift through the data available. It also utilises AI to integrate ESG data with financial and momentum analysis.

In January, the UK-based company — together with its Malaysian partner, BIMB Investment Management Bhd — launched its third fund in the country. Like its two previous funds, the BIMB-Arabesque Asia Pacific Shariah-ESG equity fund will use a rules-based approach and AI to select companies that comply with UNGC, shariah and ESG principles.

The fund currently has shareholding in about 140 companies, selected from 7,500 companies in Asia-Pacific except Malaysia and India. Malaysia was excluded to avoid overlapping with a previous fund that focuses on the country while Indian stocks are currently trading at expensive valuations, according to Karageorgiou. The fund has both ringgit and USD share classes, with minimum initial investment of RM500 or US$500 respectively.

BIMB Investment CEO Najmuddin Mohd Lutfi says it decided to focus on Asia-Pacific because of the growth trend. “The growth engine for the world’s economy is still coming out of Asia-Pacific, largely because of China and inter-trade in the region. These are driving growth rates for the region and I think the gross domestic product growth is still much higher than the global economy as a whole.”

But companies with insufficient ESG data — even if they are located in China and have huge growth potential, for example — will not be included in the fund. “If we do not feel comfortable with the number or quality of the data, we will not get exposure to the country just for the sake of being in China. For every company that enters the portfolio, we need to be very comfortable with it on the different dimensions of analysis that we perform,” says Najmuddin.

The list of potential companies are narrowed down through screenings for liquidity requirements, UNGC and ESG principles, shariah compliance and financial performance. The two previous funds launched by BIMB and Arabesque are rebalanced daily and monthly, but the latest fund is only rebalanced quarterly.

“For us to make a decision we are comfortable with, to apply the daily allocation, we need to have a lot of companies to begin with that have sufficient liquidity. The more we restrict the universe, the fewer companies we have,” says Karageorgiou.

There is no fixed sector or country allocation for the fund. “The process is 100% bottom-up. One thing you will find in all of our funds is that we do not take a view from the beginning, so we are not going to say we want to have exposure to certain countries and start picking stocks. The way it happens is that we analyse all the companies and gather the ones we like. And if 15% of them are in Japan, then they are what we will invest in,” says Karageorgiou.

The BIMB-Arabesque Malaysia Shariah-ESG Equity Fund and the BIMB-Arabesque i Global Dividend Fund 1 were registered in Singapore in January. The Malaysia fund also has a Singapore dollar share class.

As at Feb 2, the BIMB-Arabesque i Global Dividend Fund 1 ringgit share class was ranked No 1 in the global equity Islamic category, with a return of 13.08% over one year, according to the Lipper fund table. The BIMB-Arabesque Malaysia Shariah-ESG Equity Fund’s ringgit share class was ranked No 30 in the Malaysia equity Islamic category, with a return of 4.22% over six months.

Najmuddin says BIMB Investment plans to launch a mobile app for its investors this year. “Investors can directly invest with us through the mobile app. One of the things we have to address is the Know Your Customer measures. We want to make it electronic and go paperless. That is our big project,” he adds.

“This year, we are also quite comfortable with the improved market sentiment. We had a great 2017, with our assets under management growing 100% to RM2.3 billion.”