Integrating Alternative Data (Also Known as ESG Data) in Investment Decision Making

Abstract

What is environmental, social, and governance (ESG) data and how do we evaluate its quality and effectiveness? This form of evaluation is important, as it is a precondition for investors trying to integrate ESG in investment decisions. Previous literature describes intrinsic properties of ESG data (e.g., multifaceted-ness and context dependence) and highlights a trade-off between the validity and reliability of ESG data, which is often tied to the lack of theoretical foundations and scarcity of high-quality ESG data. Encouragingly, new data technologies have improved the accessibility, availability, and transparency of ESG data, but an agreed theoretical framework to evaluate ESG data quality is still lacking. This paper seeks to fill that theoretical gap by proposing a “user-oriented” approach to evaluate ESG data. In this framework, we consider ESG data to be a “continuous concept with limitless boundaries” and characterize it in terms of its width and depth. The bearing of width and depth on ESG data quality is ultimately a function of the investment decisions in which such data is used: the approach we endorse is therefore user-centric. This study then shows how ESG data, when it is of high quality, maps onto the investment decision-making processes. We identify six dimensions of ESG data quality – reliability, granularity, freshness, comprehensiveness, actionability, and scarcity – and explain how these contribute to better decision-making inputs (and better ways of assessing intermediate investment objectives), especially when set within the context of some of the primary variables that investors use in decision making.