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ESG Provides Impetus to Drive Front-Office Performance

Specialized expertise and alternative data are keys to competitive advantage in sustainable finance

Friday, October 8, 2021

By Elaine Chim

Half a century ago, Nobel laureate economist Milton Friedman called corporate social responsibility “hypocritical window dressing,” saying executives who prioritized anything but profits “reveal a suicidal impulse.”

Friedman was correct to assert that companies' first priority is to make money. If he were alive today, however, he might qualify his thoughts. There is nothing wrong with taking stock of how companies impact the planet where they hope to grow and prosper in the future.

Gone are the days when investing with environmental, social and corporate governance (ESG) factors in mind was a curiosity for private markets investors. Today, ESG is good business and doesn't require a return sacrifice - quite the opposite, in fact. Investors and funds are taking sustainable finance seriously and rushing to take advantage of it.

PWC cites research finding 45% of FTSE 100 companies have an ESG measure figuring into executive pay, and 78% of board members and senior executives agree that strong ESG performance contributes to organizational value and financial results. Those are telling figures: Attitudes toward this revolution in finance have changed dramatically since Friedman's comments.

Investor demand is partly driving the shift. In the U.S., sustainable funds attracted more than $50 billion in capital in 2020, doubling from 2019, according to Morningstar.

Regulatory Push

Regulators are also applying pressure. The European Union has introduced its Sustainable Finance Disclosure Regulation (SFDR), designed to push financial services firms to incorporate ESG considerations in every aspect of their businesses - from their own company to the portfolio of businesses that they invest in.

The U.S. Securities and Exchange Commission is considering implementing ESG-related rules. In March, the commission launched a web page to keep investors apprised of the latest agency actions on ESG in response to increased investor demand for this information. The agency also created a Climate and ESG Task Force in its Division of Enforcement. If the SEC moves forward in the European vein, it will likely implement reporting standards to make it easier for investors to compare firms' sustainability efforts.

Understanding that incorporating sustainability into investing is no longer optional anymore to stay competitive is one thing. But how do private markets investors make the most of the opportunities that sustainable finance offers to stay ahead of the pack and generate healthy returns for institutional investors?

One way is to embed the notion that ESG offers an opportunity in the form of a treasure trove of data - big, beautiful alternative data. This data is inherent to ESG. In fact, ESG is now the alternative data. The challenge is figuring out how to use it effectively to inform investment decisions, and to boost front-office performance and generate alpha.

Elaine Chim Headshot
Alternative data is “inherent in ESG,” Apex's Elaine Chim writes.

Start Up Front

To get to alpha, first of all, ESG must be assumed as critical to front-office performance. Second, make sure that the front office is all that it can be.

To fully achieve the benefits of ESG, it's crucial to marry the financial expertise of front-office investors with the data-crunching capabilities of middle and back offices or trusted partners in fund administration. Some private equity firms, seeing the value of integrated, diverse teams, are already moving to make sure that is happening.

Many fund managers say you can't find alpha in alternative data with generalists or financial analysis folks. You need data crunchers as well as people with expertise in sustainability issues such as environment and civil rights, among others. In essence, that means multidisciplinary teams to sit next to and engage with the team leaders and investment committees.

Think of this collaboration as an expanded front office, enhanced to help an investor to maximize the potential of ESG.

“Hybrid Talent” Required

While AI and machine learning have advanced tremendously in recent years, making it increasingly easier to collate publicly available types of alternative data from annual reports and regulatory filings, staying ahead of the market is a task that technology can't handle alone quite yet. Especially for investors in the private companies that make up 99% of global business. At the same time, too few people have expertise in both crunching the data and performing financial valuations, as former Neuberger Berman chief data scientist Michael Recce has pointed out.

He sees the future as one where money managers will combine mathematical and statistical capabilities with old-school financial valuation knowledge to improve their investment diligence-and making capabilities.

“We're in this situation where there's a lot of incomplete information in the market simply because the general investing world doesn't know,” Recce told MarketWatch in 2019. “The data is clearly there, it's not being digested. There's a lot of inefficiency in the market as a result of this lack of information processing.”

He worried that this much sought-after "hybrid talent" would continue to lag without efforts in the market and at universities to build it.

Conversely, fund managers can create a competitive advantage by seeking external resources to shore up their front office to equip it for alternative data analysis. In the future, front-office performance is going to depend on it. Friedman would approve.


Elaine Chim is head of private equity, Americas and APAC, at Apex Group Ltd.




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