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REFILE-INSIGHT-The fund managers, the sleuths and the mystery of the missing ESG

Mon, 7th Sep 2020 07:00

(In Sept. 7 story, corrects spelling of Truvalue Labs in
paragraph 23)

* As ESG industry booms, investors say risks are piling up

* Detective work varies from web trawls to full

* ESG ratings system has flaws, still maturing as industry

* Wirecard, Boohoo problems highlight potential ESG risks

By Tommy Wilkes, Sujata Rao and Simon Jessop

LONDON, Sept 7 (Reuters) - If fund managers are serious
about clean investments, they need to get their hands dirty.

That's the view of Sasja Beslik, head of sustainable finance
at Swiss bank J. Safra Sarasin, as demand surges for companies
that perform well on environmental, social and governance (ESG)

He himself has turned ESG detective in the past, flying to
southern India after reading studies that found high water
pollution levels around some factories mass-producing medicines.

Accompanied by a cameraman, Beslik spent 10 days meeting
villagers and taking samples from streams close to the plants
supplying companies that his then-firm had invested in.

He said his samples were confiscated by airport authorities,
but that he sent his video evidence of foaming scum in streams
to 27 international and local companies with operations there.

"We got a response in a week from all of them," he said,
adding that most were keen to fix the problem. Returning to
India a year later, he found many of the factories had "improved
the capacity of the water-treatment plants".

Beslik's visits were in late 2017 and 2018, but he says it's
now more important than ever to probe ESG credentials, rather
than relying on ratings assigned by data providers that are
often based on self-reporting by companies.

Investor demand for companies deemed to have high ESG
standards has never been higher. ESG-focused funds manage $1.1
trillion, more than double 2016 levels, according to industry
tracker Morningstar.

As much as anything, such investments are a way to mitigate
risk; Bank of America estimates more than $600 billion of S&P
500 company market capitalisation alone was lost to "ESG
controversies" in the last seven years.

Recent high-profile examples include German payments firm
Wirecard and British fashion retailer Boohoo,
where allegations of accounting fraud and factory labour abuses,
respectively, erased years - and in Boohoo's case, months - of
returns in a matter of days.

Wirecard collapsed into insolvency in June after disclosing
a 1.9-billion-euro hole in its accounts. Boohoo launched an
independent review of its supply chain in July and defended its
business practices,
following newspaper allegations about low pay and poor
conditions at suppliers' factories in the city of Leicester.

Beslik, who heads a team of eight ESG specialists at J.
Safra Sarasin, is now focusing on Democratic Republic of Congo
to assess mining of cobalt, a key component of batteries used by
tech firms and carmakers. The cobalt industry has been dogged by
allegations of child labour and environmental damage.

He is by no means the only player turning ESG sleuth,
reflecting the shifting demands of the investment industry.

Vontobel Asset Management's head of ESG, Sudhir Roc-Sennet,
employs three ex-investigative journalists to bolster his
traditional team of analysts. A central element of their job is
kicking the tires on ESG scores.

One example concerned Nestle. Despite the firm's AA ESG
score from one provider, Vontobel became concerned in 2018 about
media and NGO reports of excessive water use at Nestle's U.S.
bottled water subsidiary.

Roc-Sennet remains invested in Nestle, praising its overall
environmental track record. But after consulting water rights
lawyers, hydrogeologists, and environmental inspectors, Vontobel
pushed Nestle to reduce water intensity - the amount of
freshwater used per million dollars of sales.

It's unclear whether Vontobel's efforts led to Nestle
reducing its water intensity, which had been falling for years
across its businesses.

Nestle said the amount of freshwater used per bottle at the
U.S. subsidiary was one of the lowest among beverages and its
"team of engineers, hydrologists, biologists and geologists
consistently monitors and cares for the springs and local
environment in California".

Headline ESG scores can miss such issues, Roc-Sennet said.

"The water division is small and Nestle's other business is
sustainable," he said.

When data isn't available, basic detective work is the
answer, he says.

To assess diversity among senior management at companies,
for example, he has scoured the web to check "thousands of
photos and names, doing Google and LinkedIn searches on people's


Providers of ESG scores, including Sustainalytics, MSCI and
Refinitiv, which is part-owned by Reuters News' parent company,
say that alongside company disclosures they use external sources
including media and NGO reports. Some, like Truvalue Labs, say
they eschew company data altogether.

But the system has flaws.

Small companies with limited disclosure can earn lower
scores than multinationals, meaning relatively new renewable
energy outfits might rank below tobacco giants.

Scores can also vary wildly across providers. In contrast to
credit-ratings agencies, whose assessments vary significantly in
just 0.1% of cases, one in four ESG ratings differ between
providers, according to Nathan Cockrell, Lazard Asset
Management's co-director of global research.

Take Tesla - its environmental scores range from 10% to 65%,
where 100% is the best possible score, according to a 2019 study
by Anthony Renshaw at financial intelligence firm Qontigo. Tesla
can rank both above and below rivals Ford and General Motors.

Another example is Saudi oil firm Aramco. It is rated an
average BB by MSCI but carries an ESG risk rating of "severe"
from Sustainalytics.

Boohoo scored highly across some providers when the
newspaper investigation lopped nearly 50% off its share price in
three days. That was despite long-standing media allegations of
issues in its supply chain.

Simon MacMahon, head of research at Sustainalytics,
acknowledged ESG scoring relied on information that was "quite
incomplete, sometimes inconsistent and sometimes of low
quality", but said methodology had improved.

"ESG as an industry is still maturing ... We are in the
first innings of a nine-innings game," he said.

An MSCI spokesperson said ESG ratings should be one of many
factors investors use while conducting due diligence, and are
not investment recommendations.

Many managers subscribe not just for headline scores but to
access underlying research and data, ESG data providers say.


But gaps and inconsistencies are spurring some fund managers
to determine ESG credentials for themselves. This may involve
investigating basic assumptions.

Railways usually rank highly on ESG metrics because of low
carbon emissions, but Hans Stegemann at Triodos Investment
Management found out his fund was invested in a Canadian rail
firm that transported shale gas and oil.

They sold their stake, Stegeman said, adding: "There was no
positive (ESG) impact."

A company's culture can be crucial, yet is difficult for
scoring systems to evaluate.

Sharon Bentley-Hamlyn, investment director at Aubrey Capital
Management, said a little digging can help verify management
claims. Impressed by British concrete paving firm Marshalls
, Aubrey visited their quarry in the Scottish town of

"We found great attention to detail, talked to employees and
found them very proud to be working for the company. They had
invested heavily in systems for health-and-safety training," she

Yet ESG screening can, in the short-run at least, conflict
with maximising returns - Boohoo shares are still up 120% from
2017. Managers who ditched tech stocks after 2015 on concerns
about data privacy and cobalt supplies missed a huge rally.

Beslik of J. Safra Sarasin said inconsistencies between ESG
scores and reality could ultimately leave investors exposed.

"There is a huge gap in the world of ESG investing," he
added. "A gap between what ESG investments stipulate that they
do and what is really going on on the ground. One day it will
boomerang back and it will hurt the entire industry."

(Reporting by Tommy Wilkes, Sujata Rao and Simon Jessop;
Editing by Pravin Char)

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