The Appliance of Science

Independent ESG Portfolio Analysis on Tap

In November 2024, Scientific Portfolio launched a tool that it says finally answers investor questions around analysis of ESG and climate characteristics and risks. TMI took the opportunity to dig deeper and find out how.

A platform that enables investors to analyse financial risks and performance and the ESG and climate characteristics of an equity portfolio needs to be neutral and, ideally, independent. As a venture incubated by France-based international business school, EDHEC, Scientific Portfolio can at least legitimately claim access to academic rigor as it seeks to provide investors with impartial information.

What’s more, Scientific Portfolio’s recently launched platform, explains Benjamin Herzog, the firm’s CEO, is aimed at directly supporting “actual decision-makers who will analyse an existing portfolio and proposals for new investments”. Its purpose then, he says, is to present the most relevant and usable information in the clearest and most concise format possible.

Timely intervention

ESG and climate-related data have had relatively little time to become integrated within investor decision-making, especially as pressure to ‘do the right thing’ is bearing down on businesses with ever-greater force.

With this in mind, a platform promising neutral and independent data seems timely. But the need is for more than just another flood of ESG-related content.

There are two elements for investors to consider here. First, the torrent of ESG data making it difficult for investors to articulate a clear ESG and climate policy. Second, the values-driven nature of ESG which propels  investors towards being more involved in an otherwise heavily intermediated industry.

While there are already several portfolio risk platforms available that incorporate volumes of market data, including those related to ESG and climate factors, Herzog explains that these characteristically generate “quite a learning curve”. Thus it also often requires a dedicated team of experts to run these in order to produce reports for decision-makers.

“Given the history at EDHEC of transferring academic know-how directly to business decision-makers, such as treasurers, it felt like an ideal moment to introduce a platform able to directly answer their questions, rather than them having to request a full report from their risk managers or quants,” he comments.

With the ‘non-expert’ in mind, rather than cover a vast swathe of often arcane ESG data points, the Scientific Portfolio objective has been to select a number of key metrics that would enable investment decision-makers to directly inform themselves, and then confidently act upon their understanding of the impact of those metrics on their portfolio choices. As Herzog says: “Platform accessibility is a very important point.”

The metrics selected by Scientific Portfolio reflect how investors operate in the real-world. As an example, ESG screening is a popular strategy to try to pinpoint stocks that violate certain sustainable development goals (SDGs, the collection of 17 global objectives established by the UN), and then exclude these from their portfolio. 

To help investors better understand the most important issues linked to a given SDG, Herzog and his EDHEC team have developed a new framework. The number of related issues for each SDG has been reduced to a “palatable number”. This enables them to be both easily represented and customised according to the priorities of each investor. 

The platform’s ESG Screening functionality can be configured with different ESG policies or predefined ‘Screens’. The SDG Screen offers the most comprehensive coverage. The Consensus Screen is minimalised but represents the most consensual elements of exclusion within the examined investor policies of major asset owners. Users can also define a Custom Screen, selecting the issues they most care about.

With framework elements drawn both from public exchanges and Scientific Portfolio’s academic research team (via EDHEC), investors are able to use their screen as a starting point. “The idea is for each investor to be able to express their own views, be in a position to assess the impacts and risks these have on their portfolio, and then make these work within their financial strategy.”

Access all areas

The target users are primarily institutional investors. This, explains Herzog, is because this is an audience with which EDHEC has an historical connection. “The platform also serves asset managers well, as it enables them to easily benchmark a portfolio against the rest of the market.”

As an example, a low-carbon ETF may seem to reduce a carbon footprint. But when considering its tracking error (the degree by which a portfolio is aligned to its benchmark), it provides a clearer view of its relative efficiency versus other funds. This enables users to discover if there are better-performing funds with the same level of tracking error. In other words, it enables a like-for-like comparison.

And when a portfolio is changed, it will indicate how and why its tracking deviates so that investors can review its value. Here, fund performance could be expressed in terms of carbon reduction, but also through the mechanism behind that reduction, which could be based on sector reallocations, or intra-sector stock-picking, says Herzog.

“Our research will explain, depending on what the investor is trying to achieve, whether their metrics indicate they are on the right path or not, and if those metrics are exploiting tracking error in order to achieve fund goals, or if there are other elements to take into account.”

State of independence

While Scientific Portfolio is geared to user accessibility, its independence is an important element to consider too, insists Herzog. Given the cost of acquiring the data, and the subsequent research, he says it can be challenging to provide impartial insight. In most cases, he suggests investors will receive information from large asset managers and major conglomerates. “But we’ve seen a lot of aggregation in the market recently, and it’s increasingly difficult to find data points that haven’t been already aggregated. Independence has become quite rare.”

Scientific Portfolio has been incubated in the EDHEC ecosystem for almost three years, during its research phase. “Its independence is an important element because there are many data providers out there, making it difficult for investors to gain usable clarity,” says Herzog. “We focused on keeping everything extremely simple while still addressing the main issues concerning investors today.”

To achieve this, the team purposefully chose a small number of metrics. “You don’t need a million metrics and data points to make a good decision,” states Herzog. However, researchers still had to review “pretty much every dataset available” to make that selection.

“Our team spent 18 months looking at several carbon datasets, ESG datasets, and negative and positive screening datasets, analysing their coverage and consistency,” he explains. “We knew we couldn’t cover an issue effectively if we didn’t understand the data actually available.”

The alternative, he notes, “would have been to speak to some company that tells you it has AI that resolves all the data problems”. However, his instinct was that “it’s not that simple”. “What goes in is super important – we knew that it would require considerable investment in research. And it looks like no one else has the time and capacity to do that.”

Sources of truth

The data used by Scientific Portfolio is acquired from a number of providers, the focus being, as much as possible, on acquiring raw data. While Scientific Portfolio still has strong partners providing this, Herzog says it’s becoming more difficult to find raw data “because most providers want to sell scores and sophisticated data analyses”.

By processing that data, each provider is, of course, applying its own interpretation, which could be counter to Scientific Portfolio’s aims. “Our data must enable us to pursue a given objective,” asserts Herzog.

Within its research framework, the team will create specifications for what it is trying to achieve. It will then try to find data providers that match that aim as closely as possible. Sometimes it will require a combination of different providers for a single project. It will then analyse the coverage, and probe data samples to assess accuracy, comparing one provider with another.

Where data is estimated (as opposed to reported), it’s vital that the estimation methodology is transparent. “It’s not always the case”, reports Herzog. These elements can be important, so where an over-simplified estimation methodology has been adopted by a provider, he says he would rather seek out the raw reported data because this enables Scientific Portfolio to create its own estimation methodology to complete the picture.

Another selection criterion for data is that it should enable users to discriminate within sectors at a granular level. “If it can’t enable that, then it’s not that interesting for us,” admits Herzog. Indeed, with the platform’s goal of showing investors the impact of pursuing a given extra-financial objective on their financial risks, drilling down to individual stock level is very important.

Deep-dive data

In order to effectively pursue some forms of impact strategy – global decarbonisation of the economy, for example – investors must incorporate traditional industrial businesses, comments Herzog. “The economy cannot function if we can’t produce or transport basic materials. These are high-emission sectors, but we still need them. Their transformation must therefore be financed by investing in the best among them –  not removing them all from a portfolio just so investors can achieve a small bottom-line uptick in terms of their own carbon footprints.” Of course, this is just one approach, but Herzog adds, “in investment terms, it requires intra-sector data; in other words, individual stock-level data is essential.”

Incorporating an understanding of transition risk – essentially the risks arising from the speed of transition, and how this affects certain sectors and financial stability – has become an important element of the platform. This is because the notion of double materiality, the degree to which a company’s social and environmental impacts relate to its financial performance, is also now important for many stakeholders.

An investor may be looking to understand how exposed their portfolio is to climate-transition risk, and then wish to explore how it could possibly mitigate that risk through different reallocation or exclusion strategies, for example. Alternatively, they may wish to implement a climate-alignment approach, adopting a broad climate-impact strategy, including investment in green-revenue companies.

The challenge is for the investor to find the right trade-off between the implementation of this extra-financial strategy and its financial risks. Herzog believes that it’s not entirely possible to completely disentangle climate-transition risk from other types of risk. “This is why we enable investors to analyse the risk and the performance breakdown, either by traditional means, or by incorporating climate transition risk.”

Informed decisions

Investors will be able to use Scientific Portfolio to directly inform strategy adjustments. Herzog explains that most will consider the evolution of sustainability frameworks, climate regulations, and the accounting of extreme climate risks, as part of their fiduciary duty. And, for one reason or another – perhaps purely risk-driven, performance-driven, or values-driven – they will at some stage have to implement certain changes.

“These changes can be huge, and they are rapidly building momentum and speed,” he comments. “We’re here to help decision-makers, such as treasurers, to be more agile, interacting with their internal teams and product providers in a more engaged manner, because now they can test and view the wider impact of their decisions themselves.”