By Jay Nair, SVP, Industry head, Financial Service and Public Sector, Infosys.

The environmental, social, and governance (ESG) investing movement was born 17 years ago at the United Nations’ Who Cares Who Wins Conference. The U.N. concluded that this approach was needed to manage risk, anticipate changing regulations, access new markets, increase brand value, and fuel sustainable development.

Now, this investing strategy is finally approaching maturity. Bloomberg Intelligence estimated that the market is already worth $35 trillion and set to reach $50 trillion in just three more years — an opportunity that can’t be ignored. No longer a niche market, ESG investing is a core component of the global pool of money. At the same time, ESG investing strategies are attracting a higher degree of scrutiny, such as the U.K.’s new regulation requiring its largest companies to disclose climate-related risks and opportunities.

ESG investments thrived during the past two years and even remained above water during the global economic troubles at the start of the pandemic. Now, ESG investments are struggling. Asset management firm Bernstein noted that the first week of March “marked a rare [and the largest] outflow from ESG funds.” No one can say for certain whether this is a brief blip — perhaps affected by inflation or other macro factors — or a sign that the staggering growth of ESG investments is no longer sustainable. For many investors, this transition creates a high-stakes test of their ability to assess these new opportunities and risks.

With more than 600 sustainability ratings, there is no shortage of inputs that can influence investment decisions. Instead of helping, however, this vast array of information often generates more noise but not enough signal. Research has consistently shown that even respected ratings agencies assess companies differently on ESG factors, making it difficult to determine which ratings are the most relevant and predictive. Correlations among major agencies are often less than 50%, compared to the 94-96% agreement among debt ratings.

Investors frequently struggle to determine the materiality of these ratings. The sometimes contradictory and nonfinancial data doesn’t always fit seamlessly into complex financial formulas and well-honed strategies. In many cases, investors simply do not have the time, budgets, or skills to harness the full potential of ESG data.

For example, an Infosys global survey found that, despite the high returns, there are workable ways that investors can develop better strategies and improve on their investment performance. This research collected responses from 455 investment and fund managers in Europe, the U.S., and the Asia-Pacific region, with similar trends in all three geographies. The results were both striking and illuminating but also suggest that more research is needed.

Investors need to collect more data

The financial services sector is data hungry when it comes to traditional sources of information. However, firms overall are not collecting and analyzing enough data and enough different data, according to our research.

The survey found that investors who reported the lowest returns from their ESG investments were the ones who relied entirely on ratings from external agencies. The firms that only used in-house metrics performed better. However, the investors who used both in their decision-making reported the highest returns from their ESG investments — 6.9% higher than the S&P 500 in a bull market.

Looking a level deeper, we found even more differences in investment performance based on what data firms use to create their internal ratings. Investors that used ESG data reported directly by the companies had an average performance that is about 1 percentage point higher than those using external ratings only. This performance increase was 0.8% higher for companies that use ratings agency data, not just the ratings themselves.