The Data Road Less Traveled - What We Have Learned Thus Far
The opportunity to work with severely underutilized and often misunderstood data sets played a significant role in my decision to join Terra Alpha Investments (TAI) back in March 2015. TAI is an advocacy investment firm that seeks to generate better returns, a better environment, and a better world by investing in global, publicly-traded equities. We invest in companies with strong, sustainable business models that are better equipped to deal with the challenges of a changing and increasingly-resource-constrained world. Our Environmental Productivity™ data sets and analysis allow us to identify such companies.
Environmental Productivity™ measures the efficiency with which companies use and impact natural resources. Just as corporate managers measure and analyze labor productivity and capital productivity, Environmental Productivity™ can be used to quantify how productive a company is at using nature. At its core, it is a measure of operational efficiency. Environmental Productivity™ is calculated using company-reported emissions, water, and waste data and is a vital component of multiple stages of TAI’s investment process.
As we have constructed our Environmental Productivity™ data set and spent time researching and analyzing the various components, there are many things we have learned about the data from an investor’s perspective.
First, while estimated data can be helpful in measuring the environmental impact of an investor’s portfolio, it is less relevant for assisting with stock selection. A key premise behind the concept of Environmental Productivity™ is that “if you measure it, you’ll manage it.” Since it is meant to be a gauge of operational efficiency, estimates of a company’s emissions profile, water use, or waste generation from a third-party provider are far less meaningful than reported numbers from the company itself. A company that is measuring and disclosing its impact is more likely to be creating strategies to manage and reduce its impact.
Second, corporate environmental data is not yet ready to be used in a purely passive quantitative investment approach. There are nuances to most (if not all) data sets, and this set of data is no different. In some cases, there are companies that do not report data for all operations. In other cases, differences in business models and manufacturing processes can bias cross-company comparisons. Furthermore, the data doesn’t always translate to management intentionality or a forward-thinking culture. Therefore, it is important to analyze this data with a more active approach in order to better understand the details of the data and to be able to integrate it into traditional fundamental analysis.
Third, we are still only scratching the surface of this data set. For there to be widespread adoption of Environmental Productivity™ analysis within investment processes, the data needs to advance. It needs to advance to the point of almost being able to be used on a passive basis. More companies need to be disclosing the data in a fairly standardized way (progress is being made on this front). Companies need to be measuring and disclosing data on all operations. They need to be setting targets with clear strategies. They need to be integrating this data into their annual reports and demonstrating intentionality in regards to improving efficiency. In other words, more companies need to treat this data as any other material financial data set. Likewise, investors need to do the same. Investors need to demand improvement, provide accountability and incentives, and demonstrate materiality.
Instead, we find ourselves facing several dilemmas. Many companies aren’t spending resources to gather and report on this data because most investors aren’t demanding it, while many investors aren’t demanding the data because most of the data has not been robust enough yet because companies aren’t spending resources on it. Similarly, asset owners tend to not want to invest in funds that use this data and information because there isn’t enough of a track record, while funds that use this data can’t establish a legitimate track record because asset owners are hesitant to invest in them.
In the end, we need more participation across the board. We need more companies recognizing the benefits of adopting sustainable business practices and sharing information on their efforts. We need more investors using this information in their investment processes, rewarding those companies that are mitigating risks and realizing opportunities, and generating higher risk-adjusted returns by investing in such companies. We need more asset owners to help drive this transition by understanding that generating competitive returns while reducing the environmental impact of those investments is an opportunity to put that money to work and make a difference without having to sacrifice return. We need a shift in thinking from the short term (i.e., the next quarter) to the long term (i.e., the next several years). Those that are willing to take the lead and consider thinking about the long term may very well find themselves in a position to generate better returns, a better environment, and a better world.
Dan Sanborn, CFA – Partner, Director of Investment Data & Research