Applying environmental, social and governance (ESG) criteria to investments can be hard. Data is often lacking or not easily comparable, leading some investors to give up.
A paper from two professors at Western University’s Ivey Business School makes the case for not bothering to integrate ESG factors into financial models. “The inability to design calculative devices that assign a market value to ESG criteria often leads to ESG issues being abandoned,” the authors wrote. For three years, they studied a French asset management company whose equity managers settled on a novel approach to communicating ESG factors: emojis.
The firm’s fixed income managers attempted to integrate quantitative ESG criteria into financial models. They found the criteria too difficult to reconcile and, as a result, gave up on including the factors in their investment processes.
The equity managers, on the other hand, used emojis to assess ESG criteria. Those assessments remained separate from financial numbers (for obvious reasons) and introduced a different way to communicate a company’s performance. The emojis’ qualitative values led the equity managers and ESG analysts to create an investment decision matrix juxtaposing ESG and financial criteria so the managers could identify companies with the best balance of the two.
Using a visual led to the equity managers incorporating the social factors into their investments, whereas the fixed income managers did not.
It turns out the emojis, such as a indicating “dynamism” and a to signify “dull,” allowed the equity managers “to distance themselves from their own calculative devices to better identify the factors that financial markets did not seem to value,” the paper said. This created a “dissonance” that the authors argue encouraged deeper thinking and judgment.
In the period since the study (2006 to 2009, with follow-up interviews in 2015), ESG data has become easier to incorporate into financial models. But there are still large gaps, particularly in emerging markets, where unorthodox approaches could be useful.
Read the full paper, “Beyond Numbers: How Investment Managers Accommodate Societal Issues in Financial Decisions,” (Organization Studies, 39 (5), June 2018)