Global head of ESG methodology at Morningstar Sustainalytics explains where Canada's at with regards to ESG data, and how non-financial metrics can help firms assess risk
It’s perhaps a trope or even a cliché of Canadian identity that we sit somewhere between the US and Europe on so many things. Whether it’s our social safety net and labour laws, our social values, our multiparty democracy, or our business culture, Canadians find themselves explaining to our European and American counterparts how we’re just a little bit like both jurisdictions. At this point in time, we can add ESG to the list of Canadian attributes that feel distinctly transatlantic.
Where Europe has been well known as an ESG leader, both due to regulation and investor demand, the US has seen more of a pushback against ESG — largely via retail investors. Clark Barr, global head of ESG methodology at Morningstar Sustainalytics, explains that Canada has seen both progress and pushback in the adoption of ESG. He explained some of the ESG methodology applied at his firm as well as how Canadian companies are using it. He drove home that while ESG is often viewed through a political lens, applying some non-financial metrics in assessing an investment can help investors appropriately assess risk.
“The research we’ve done has shown that Canadian companies are somewhat better prepared and positioned in terms of ESG than the global average, but are still behind Europe,” Barr says. “That’s just about across all metrics. European companies report more and have better performance on key best practices that we look at.”
Barr’s view is based on a 30-year history of ESG data collection. Morningstar Sustainalytics, he explains, now collect over 3000 datapoints around ESG. These are factors as diverse as a company’s water consumption and its whistle-blower policy. They can build ratings products based on those datapoints which can, in turn, inform investor decisions around ESG.
While ESG has become politicized in a few arenas, Barr prefers to consider the approach as simply a complement to traditional financial research. Where a financial research firm would collect data around a company’s revenue, liabilities, and margins, a firm like Sustainalytics will look at the number of employee deaths, a firm’s turnover rate, and pollution best practices. Given some of the idiosyncratic risks that can emerge from non-financial factors, there may be some value in knowing that information.
Some Canadian investors are now using those metrics as a screen to weed out ‘bad actors’ from their portfolios. Others are using ESG scores to highlight where they may want to engage with a company and improve its practice.
Some ESG marketing, especially before 2022, highlighted that ESG portfolios tend to outperform non-ESG portfolios. Barr pushes back on that idea, noting that ESG didn’t originate as an alpha-generation strategy. Rather it began with an idea of making portfolios more value-aligned. Moreover, he notes that while some comparisons will show ESG outperformance, the nature of investment indexes and time horizons is such that simple data selection can show outperformance of almost any strategy, at least on the surface.
The utility of ESG, Barr notes, comes in both the creation of a sense that a portfolio aligns with an investor’s values, and in protection against some idiosyncratic risks. Perhaps counter-intuitively, one of the major Canadian sectors that uses ESG data is oil and gas. He notes that many Canadian oil & gas firms are stronger across many ESG criteria than other companies. They look at ESG data around pieces like workplace safety and governance, as well as environmental issues like carbon emissions and water consumption. Not only do they see a shift coming away from fossil fuels, but they know that if they consume less water — for example — they will save on costs and improve their margins.
Even as one major Canadian sector uses ESG data, Barr notes that Europe tends to lead us in ESG adoption because their regulations and taxonomy around ESG are far more advanced. Canadian regulations tend to adapt similar European pieces for our own context.
As Canadian asset managers look at where this country sits globally with regards to ESG, Barr continues to advocate for an informed approach. He argues, clearly, that whatever an investor’s values, having greater knowledge about the company they want to invest in can be helpful in driving returns.
“If you’re only looking at financial data, you’re only seeing part of the picture,” Barr says. “And we do see cases where risks and opportunities arise for companies from ESG factors. One example I’ll give is with Boeing and Airbus. Looked purely financially, they’re similar in size, have a similar number of employees, and a similar level of market cap. But if you aren’t keeping track of the quality issues we see at Boeing, you might make a different decision if you only have financial information. We track those quality issues. It’s that extra information that can lead to a different decision.”
