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Relying on Corporate Transparency: Q&A with Aperio's Mark Bateman

Values-Aligned Investing
December 15, 2017

When investors want to align their investments with their values, they need to develop a clear picture of a company's record, which can sometimes be difficult because the data simply aren't available. Aperio Director of ESG/SRI Research Mark Bateman was on the original Steering Committee of the Global Reporting Initiative (GRI) that defined standards for corporate data disclosure. He believes good progress has been made in improving data disclosure over the past two decades; but since company disclosure is still not universal, he knows there’s a long way to go. In this Q&A, Bateman explains what investors should understand about data disclosure when making investment decisions.

Q: Why is it important for companies to disclose data about their environmental, social, and governance (ESG) track records?

What gets measured gets managed, and what gets disclosed had to be measured. If something isn’t disclosed, we don’t know if it was measured, and therefore don’t know that it’s being managed. Portfolio managers who want to use ESG information as part of their processes (either to reflect the values of their investors or as the basis for an investment thesis based on sustainability) can’t do their jobs without information provided by companies. In addition, if we want to learn whether ESG issues are material to the investment process or to the running of a business (which is a slightly different calculation), we need more universal and better data to be able to do the analysis. When we don’t have good, comprehensive data, we can’t know whether we’re missing an investment factor or not.

Q: What do clients typically ask Aperio about data disclosure?

Clients don’t often come to us with a question about data disclosure. Instead, they ask about an ESG issue area, and we explain the state of data disclosure for that issue area where the information we have is based on voluntary disclosure. We explain why the data are available only for some things and what the implications are to the original question.

Q: What are some of the questions you get from clients?

1. Board Diversity: There are two categories of data about the makeup of the board—gender and racial/ethnic. Research firms publish gender diversity numbers but not racial and ethnic data. Since it’s not disclosed, we can’t answer that question for clients as part of our portfolio construction process.

2. Workplace Diversity: For example, what are the proportions of women and minorities in a company’s total workforce? Every company with more than 100 employees in the US is required by the US Equal Employment Opportunity Commission to report the statistics about their workforce, but the federal government considers those reports to be proprietary and not subject to Freedom of Information Act requests. Researchers and investors have access to this diversity information only if a company voluntarily discloses it. Companies can very easily disclose this information at virtually no additional expense, but the vast majority of them don’t release this information. ESG researchers and investors don’t need color photos or lots of narrative with anecdotes, they just need the data, which could be provided as simply as posting a PDF of the EEO-1 form.

According to IW Financial data as of November 2017, in the Russell 3000 Index, less than 15 percent of companies disclosed the percentage of women and minorities in management and in the workforce.

R3000 companies failed to disclose

3. Carbon Emissions:
Many investors believe that carbon emissions are material to their investments and have pushed companies to disclose their emissions. While disclosure has increased over the years, it’s still not universal. Incomplete data sets can make it difficult to build low-carbon portfolios, as just one example of how emissions data is used. To plug this hole, several research firms have developed models to estimate carbon emissions when the company hasn’t disclosed them. Aperio uses MSCI’s version of this data, having decided that an estimate, in this case, is better than no data. Within MSCI’s data set (as of November 2017), 434 companies in the Russell 3000 disclosed emissions data (though this represents 67 percent of its market capitalization); the remaining companies have their emissions estimated, or in a few cases, are not covered by MSCI.

Q: What types of issues are most impacted by lack of data disclosure?

The analysis of any issue area that relies on voluntary disclosure of information by companies is hurt by a lack of disclosure. Some of the issue areas where there is the least disclosure include diversity, energy use, and water use.

Q: What excuses do companies give for not disclosing?

Companies frequently argue that issues aren’t material to running their businesses or that collecting and reporting the data is too expensive. I think that some feel they don’t have good stories to tell. They are concerned that if they’re not doing well, it will hurt their reputations and sustainability ratings. They would rather have no score than a bad score.

Q: What can be done when companies don’t disclose their data?

When a ratings firm or asset manager encounters a lack of data or an incomplete data set, they have to decide how they are going to interpret that company’s lack of data. There are a few approaches to this.

One option is to penalize a company that does not disclose. When evaluating performance on a particular topic, if a company doesn’t disclose the necessary data, then that company will receive a rating or score worse than any company that does disclose. This certainly creates the possibility of distortion between what companies are doing in the real world and what the ratings show. For example, a company with decent performance that doesn’t disclose its data will receive a worse score than would be warranted if the information were available.

A second approach is to hold companies that don’t disclose as neutral. This also creates the possibility of distortion—a company with bad real-world performance on a topic will score better because of its lack of disclosure. This method sends a signal that there can be a benefit to not disclosing information.

A third solution is to create data that estimates performance when the necessary disclosure isn’t available. This is the approach that several research firms have taken with carbon emissions data and the basis for Aperio’s Low-Carbon offering. The advantage of this is that data are comprehensive (something related to every company). The disadvantage is that all the data may not be completely accurate.

Q: When you explain this, what has been the response from investors?

It’s eye-opening for people to realize that certain information isn’t available. I think they appreciate understanding the complexity of the research challenge and that we’re up-front about what we have and what we don’t have. At Aperio, the ratings we construct for clients penalize companies that don’t disclose (except where we have estimates). Some clients say that’s okay and will choose to use that data element. Others aren’t comfortable with that approach and will not include the data element in their profiles. We’re fine either way. In either case, the client has determined what available information will inform the evaluation of companies that best reflect their values.

Q: Are some industries better than others at disclosure?

Perhaps counterintuitively, “dirty” industries tend to have higher levels of disclosure than “clean” industries. For example, you’re more likely to see a sustainability report from a utility or chemical company than from a financial services firm. In addition, companies that have been through a specific controversy will often have more robust reporting than other companies that haven’t. And finally, larger companies are more likely to publish corporate social responsibility or sustainability reports than smaller companies. This can mean that some companies that score well on disclosure are among those people don’t typically think well of. Disclosure can be an indication of higher levels of stakeholder engagement, which is often sparked by controversy.

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