At the heart of Fidelity's sustainable investing strategy is a proprietary Environmental, Social and Governance (ESG) ratings approach rolled out since 2019 and being refined during 2021. Much of the industry, Jenn-Hui Tan says, follows a 'quantamental' model, which assembles data about a company from a variety of third-party sources and weights each in various ways depending on industry sector and other materiality-based factors.
The benefit of top-down rating models is that you can scale them quickly, for example, to cover over 10,000 issuers, so long as you can access data. But Tan has doubts: "The first problem is that you are really only as good as the data that you are buying," he says, "and most data is non-standardised, non-verified, and not necessarily comparable."
The second is a broader philosophical problem. "When a few years ago we used quantamental ratings to show portfolio managers how sustainably their funds were constructed, we found they might agree they had a D-rated company but argue that was because they believed the company would improve going forward," he says. If correct, that belief might be critical in directing capital towards positive change, but it needed to be documented and its validity tracked.
"We realised, going into 2019, that if we wanted to integrate sustainability in a genuine way to our investment process, we'd need to integrate ex-ante rather than ex-poste: it must be part of the way fund managers make their investment decision," he says. That meant building sustainability ratings using a more ground-up approach.
So the team rebuilt their model and put it in the hands of the analysts who drive the Fidelity business. "We told them, we've built this for you but, company by company, you're the ones that have to do the research. Find the data, get it from primary sources, or whatever sources you can including company meetings. If you can't do that, form a view in the face of uncertainty. Then create an ESG rating."
The big difference between Fidelity's proprietary ratings and most third-party ratings is their forward-looking nature. "If you're rating is based on what companies are disclosing, then you are rating what they've done in the past; you're not trying to forecast," he says. "Our analysts consider what companies have done in the past because it's an important indicator of what may happen in the future - but our approach is based on our company interactions and therefore places a greater weight on a company's direction of travel with respect to sustainability."
Using analyst expertise also helps the firm to build ratings that focus on the core sustainability topics for each sector - taking account of local peer and market practice - which is especially important in areas such as Asia, where Fidelity is a leading investor. Tan believes that none of the key global challenges can be solved without addressing Asia.
Fidelity's new ratings approach, launched in June 2019, had achieved coverage of over 4,400 issuers by early 2021, and this year the firm is embarking on an ambitious revision of the granularity and focus that its analysts place on each key sustainability factor.
The revision will also shift the focus further away from financial materiality towards what Tan calls ‘double materiality'. "The dominant view previously was that investors looked at ESG factors because they posed a material financial risk to the company", he explains. "But increasingly we also want to ask much more directly: What is the material impact of companies on the environment and society?"
Click here to explore our new interactive guide on Fidelity's distinctive approach to sustainability - and how this informs investment decisions while powering positive change in the world
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