"Technology - What's in it for ESG investing?"
From the Global Financial Crisis to the Covid-19 pandemic, the world is becoming more aware of the importance of sustainability. Gurinayat Brar and Jaeyeon Park take a look at the technological trends poised to be the future of ESG investing
Whether human-induced or not, turbulence is inevitable, and human beings are now increasingly accepting of the fact that some of the shaking could have a significant impact. In addition, the active usage of social media due to technological development has brought us into the age of moral outrage.
With all these changes taking place, one type of business model is becoming all the more popular - it is called ESG. The significance of ESG factors in business management is being emphasised by many to the extent that experts argue ESG management should be taught explicitly in business schools. Indeed, this trend has affected the field of investment as well. The Norwegian Sovereign Wealth Fund decided to stop investing in 366 companies with seemingly unsustainable business models. Nest dumped Exxon Mobil, an American multinational oil and gas corporation, over climate change risks. Japan is now using foreign reserves for ESG investments. The list really goes on and on.
(Image Source: https://corporatefinanceinstitute.com/resources/knowledge/other/esg-environmental-social-governance/)
If there is another thing we have learned over the past few years, it would be how fast we were able to develop the technological equipment to meet our needs. Before the pandemic, many of us were unaware of how the usage of online calls could be expanded; however, nowadays, most of us are active users of Zoom or Microsoft Teams, regardless of our vocations. There are now many virtual events taking place like virtual internships or virtual open days, which went unheard of prior to the pandemic. Considering the rate at which technology has adapted over the last 2-3 years, it would not be a surprise at all that technology plays a huge role in ESG investment as well. In this article, we will focus on how various types of technologies may enable investors to make more informed investment decisions.
Improvements in the accuracy and transparency in ESG investment
The development of financial technology has allowed people to have a more accurate analysis of financial portfolios in general and especially has allowed the analysis of ESG factors to be more accurate. Investors are now more able to make optimal investment decisions using data analysis tools. Moreover, the development in AI has led to increased productivity of financial advisory services along with fintech development. For example, last October, NEC, a Japanese multinational IT company, announced the acquisition of Avaloq, the Zurich-based world’s leading financial asset management company, in a $2.2bn deal. A month later, Avaloq launched an ESG-investment solution for banks and wealth managers which allows them to build tailored, personalised ESG-compliant portfolios for clients.
Moreover, most investment firms today have built digital wealth management platforms a.k.a robo-advisors that are able to offer investment advisory services without human supervision. Depending on the firm, these robo-advisors tend to adopt different strategies on their socially responsible investment offerings. For instance, the portfolios offered by Betterment only offer SRI alternatives for US large-cap and emerging market stocks. They claim that alternatives on small-cap, international stocks and bonds and other asset classes are likely to reduce financial gain for the customers. On the other hand, the robo-advisory service at Wealthfront allows customers to select any specific firm that they do not intend to invest in. Fidelity International offers options to customers to select from a variety of socially responsible investment options such as sustainability focused, environmentally focused, faith-based and so on. There are also more targeted robo-advisory services like Ellevest which is specifically for female investors and is aimed to support female entrepreneurs who own small businesses.
With this surge in ESG investing, the phenomenon of greenwashing has also become apparent which essentially highlights a scenario where advisors oversell the green credentials of a company in order to appeal to investors. This way investors are misguided into believing that their investments are not just generating financial gains but also contributing towards the broader good of the society. With the help of AI, it is possible to identify such falsified sustainability claims. For instance, Swiss and German academics have created a deep neural language-backed model, named ClimateBert. It is trained which is trained on climate change disclosure sentences that align with the recommendations of the Task Force for Climate-related Financial Disclosures (TCFD). With the help of this technology, they uncovered that “firms cherry-pick to report primarily non-material climate risk information”. Therefore, one can conclude that AI can not only improve returns on ESG investing but also make it more transparent.
Leading to a better future: financial inclusion
Traditionally, financial advisory services have been only available to the rich due to the notoriously high cost. As a result, there was a massive information gap when making an investment between those who are not as rich enough to afford these services and those who are wealthy and ESG investment was not an exemption to this trend. Rather, due to the persisting difficulty associated with ESG analysis, this gap was in fact larger than when it came to general investment. However, this gap is closing due to the rapid fintech and digital innovation taking place. Due to technological advancement, the financial advisory industry has become much more reliable in terms of accurate analysis. In addition to this, the cost of producing ESG portfolio analysis has reduced significantly. This means that they would have gained increased profit, which would attract others to enter the market. An increase in competition with a reduction in cost leads to a decrease in price. Hence, it is not a far-fetched idea that the financial advisory services would become more affordable, for not only general investment but also for ESG investment specifically.
In fact, if you now google ‘ESG portfolio management’ or ‘ESG investing apps’, for example, you would be able to see plenty of options. It is a general trend in these services that the users can have personalised suggestions that align with their specific investment values, which shows how technologies are being applied in ESG investments especially. One of the apps could be found is Wealthsimple, which boasts itself for allowing users to have full access to its financial advisory team irrespective of their account balance. This shows immediately that the barrier of entry to the service is lowering for those who do not have a high account balance.
(Image Sources: https://www.wealthsimple.com/en-ca?uk_redirect=1&, https://sustainfolio.com/, https://www.m1finance.com/ )
On the other hand, we could see that some of the companies that offer ESG investment advisory services with no account minimum are also offering a so-called ‘premium’ service for those with higher account balances than the threshold that they have set individually. This implies that there could be some sort of discrimination in place still depending on how much the investors have - which is understandable from the business perspective.
Nevertheless, one thing is sure - the development of technology has enabled us to move huge steps forward in the way we do ESG investment. According to a survey of AWM firms in the US, more than 70% believe that integrating AI has already improved customer experience, decision making and innovation. Moreover, 49% AWM firms said they expect to realize the benefits of AI on revenues and cost-saving them in the next two years. Therefore we can expect AI to play an even major role in the future of ESG investing.