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The future of ESG: trade-offs between simplicity and transparency, or Why I’m joining Floodlight

When I started my career working at Innovest Strategic Value Advisors (now part of MSCI ESG,) I thought I’d forever work in a small, bright, ethical corner of finance. So much for “small”: the field has ballooned since I joined in 2008: ESG (environmental, social, and corporate governance) index funds hit $250 billion this year, or 20% of the US market.

ESG is no longer niche

For decades, the narrative has been that a profit-first mentality has stifled solutions to systemic problems. Increasingly, though, companies that fail to plan for a sustainable future are seen as a risky proposition. Many investors want to make long-term investments, which means looking at the effects a business has on society and the environment.

Sustainable finance is part of the solution to many of the generational problems we need to tackle, including climate change, income inequality, and racial injustice. With the pandemic stalling the economy, the market is looking to ESG to save our financial fortunes.

Ranking the ratings

Environmental, social, and governance covers a huge range of topics. As an ESG-curious investor, where do you start? ESG ratings have become an industry unto itself. Until recently, there was no shared reference for investors to lean on. Many investors didn’t know which ESG issues mattered, how much they mattered, nor did they know how to compare a company against its peers — a crucial assessment to make buy-or-sell decisions.

To provide scores that were useful to investors, most ESG ratings companies took a sensible approach: they created ESG frameworks themselves, capturing and scoring a wide range of ESG issues to capture the full spectrum of a company’s performance. The resulting scores, designed to be comparable across industries and regions, often roll up hundreds of data points, each weighted slightly differently based on its importance to a company’s overall performance.

Comparing ratings across multiple systems is confusing. After all, 32 degrees Fahrenheit is a lot different from 32 degrees celsius. Some of this confusion is well-founded: Is a Sustainalytics score of 58 much worse than a 62? How does a BB from MSCI compare to a 60 from Sustainalytics and a B- from ISS? The problem has grown with the field, as the investors not yet familiar with ESG rating methodologies face a steep learning curve.

Where there used to be many regional players, ESG rating companies have consolidated into 2–3 global players, with a number of upstarts that keep being acquired by one of the larger firms. The roll-up hasn’t stopped: financial data aggregators are also gobbling up ESG rating companies. Recently, FTSE, S&P, Morningstar, and FactSet have all made acquisitions of specialist ESG rating firms. To add to this, the methods of researching and presenting ESG data are evolving quickly, as shown by a raft of startups. How is an investor supposed to navigate this ever-changing landscape?

Trade-offs

Presenting this information clearly and understandably is the best way to make ESG data, and therefore ESG investing, accessible. However, there is a danger in so much industry consolidation. We could end up with a standardized industry rating that locks the investor out of the raw data. A simple percentage rating might give you a basic understanding of a company’s sustainability — but can an investor make a decision on which company to invest in when the only difference they see is a few percentage points? How can they tell if a company has a diverse board of directors or a commitment to renewables? On the other hand, too much data can be overwhelming. How is a socially responsible investor meant to look at a fund and truly understand all of its impact beyond the financials?

Transparency + context & guidance

The best way forward is for an investor to be guided through the data, and allowed to add weight to the data points that are more important to them. We need a tool that helps investors find the funds or companies that prioritize the same issues they do, an investment soulmate that they can invest in both financially and emotionally. That’s why I am thrilled to announce I am stepping into a new role as Advisor at Floodlight.

Everyone’s ethics are different, just like everyone’s idea of a healthy meal can be different. Depending on the individual, a healthy diet could be vegan, keto, or paleo. Even if we can agree on an ingredient, is it organic? Is it local? Finding a meal that meets everyone’s criteria is really hard. These kinds of differences in healthy eating can’t be summed up with a percentage rating, and ESG investing is similar. Investors want a way to account for their unique interests.

Floodlight is rolling out ESG data on companies and funds that places them on a spectrum, so the investor can see for themselves which company is best suited for them, without losing visibility on the raw data points they care most about. As we progress, Floodlight will allow users to find investments based on their criteria. Investors set the standard, and Floodlight will show them their match. It’s a great way to truly make impact investing accessible to every type of investor, from a large endowment to an individual 401k.

As ESG ratings evolve, a standardized rating risks diluting the information and missing the nuance of a company’s impact. As my career has moved me across continents, I’ve seen the wave of ESG frameworks sweep across the investing world. This has led me to believe that providing investors with the right raw data, in context, is the best way to offer true transparency, without expecting investors to undertake a lot of self-education and jargon-hacking. Instead of offering an inscrutable aggregation of scores, Floodlight exposes specific, unbiased data to help investors create ESG-informed portfolios as unique as they are.

The team

Floodlight’s product is a big part of why I came on, of course. But Erin and Nate are just as important. Their kindness, humility, communication, doggedness, humor, and strategic focus has impressed me in every one of our interactions. I can’t wait to keep working with them as Floodlight forges ahead.

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Principal @ Rizoma Ventures. ESG & impact advisor, investor, and operator.

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Claire Veuthey

Claire Veuthey

Principal @ Rizoma Ventures. ESG & impact advisor, investor, and operator.

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