Ignore ESG Risk at Your Own Peril

Investors who overlook ESG-related issues may miss out on generating alpha, says data science firm RepRisk.

Investors are not always taking into account environmental, social, and governance (ESG) risks when assessing financial risks, and they do so at their own financial peril, says ESG data science firm RepRisk.

According to the Zurich-based company, nearly every big corporate scandal in recent years has been ESG-related, and these scandals can lead to reputational, compliance, and financial risks. However, the firm also says few companies have the ESG expertise to gauge how credible any public information is and analyze the severity of risk incidents.

Alexandra Mihailescu Cichon, an executive vice president at RepRisk, says that if a company wants to create long-term value, assessing ESG risks during the due diligence of a merger or acquisition will result in a deal with a more sustainable company that will enhance value creation for each company over the long term. And she says the company’s ESG Risk Platform is the world’s largest database on ESG and business conduct risks with information on more than 170,000 companies.

Provided as a software service, the platform offers risk research on companies, infrastructure projects, sectors, and countries. It is intended to identify industry-specific material ESG risks in line with the Sustainability Accounting Standards Board (SASB) standards, assess ESG risks of companies and projects, and monitor ESG risks via watch lists and an email alert. For example, it links a company or an infrastructure project to an ESG risk. And when a company is linked to an ESG risk, it gets captured in RepRisk’s daily screening and is added to its database.

The firm, which counts private equity firms, asset owners, sovereign wealth funds, pension funds, and other institutional investors among its clients, has an analyst team of about 120 people who do quality assurance and final analysis, while artificial intelligence (AI) does the heavy lifting.

Cichon adds that the platform is not only intended to manage risk, but can also be used to improve a company’s return on investment.

“This type of data can also help generate alpha,” Cichon said in an interview with CIO, citing a research report from Bank of America Securities that found RepRisk’s ESG data can be an effective alpha signal for investors. “Investors were able to not just reduce volatility, but also drive alpha performance. And they found that result across geographies, across sectors, across investment styles, and small and large caps.”

Cichon says she believes 2020 was a turning point for ESG investing because many investors had expected it to be sidelined by the COVID-19 pandemic, “but in many ways it strengthened ESG,” she said. She said companies are increasingly embracing ESG as a key part of risk management, and not just a corporate social responsibility activity.  “It showed how what happens in our economy is linked very much to what is happening in our environment and our society.”

Cichon also said that while ESG matters are important to many investors on an emotional level, particularly younger generations, for RepRisk the focus is on the risk data.

“It’s not just about the ethics or philanthropy, it’s about good risk management and driving performance for companies and value creation in the long term,” she said. “I think the tide is changing. There’s a lot of evidence we can show to people who are still skeptical.”

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