Portfolio managers and analysts are increasingly incorporating ESG factors in their investment analyses and processes. However, ESG integration remains in its relative infancy, with investors and analysts calling for more guidance on exactly “how” they can “do ESG” and integrate ESG data into their analysis
The CFA Institute and the Principles for Responsible Investment (PRI) set out to create a best practice report (Guidance and Case Studies for ESG Integration: Equities and Fixed Income) and three regional reports (one for the Americas [AMER], one for Asia Pacific [APAC], and one for Europe, the Middle East, and Africa [EMEA]) to help investors understand how they can better integrate ESG factors into their equity, corporate bond, and sovereign debt portfolios.
We are able to achieve this goal by:
- surveying 1,100 financial professionals, predominantly CFA members, around the world;
- running 23 workshops in 17 major markets;
- interviewing many practitioners and stakeholders;
- publishing more than 30 case studies written by equity and fixed income practitioners;
- analysing Bloomberg’s ESG company disclosure scores; and
- reviewing data from the PRI Reporting Framework, the largest global database of information on investors’ ESG practices.
The above-mentioned best practice report contains guidance on ESG integration in equity and fixed income investments and case studies on how ESG integration is “done” by leading practitioners. This report focuses on the current state of ESG integration in EMEA. Other regional reports focus on the Americas and APAC regions. We hope that investors find this report and its companion reports useful and that these reports help investors learn how they can better integrate ESG data into their analysis and investment decision making.
Our main findings include the following points:
- There is no “one best way” to do ESG integration and no “silver bullet” to ESG integration.
- governance is the ESG factor most investors are integrating into their process.
- environmental and social factors are gaining acceptance, but from a low base.
- ESG integration is farther along in the equity world than in fixed income.
- Portfolio managers and analysts are more frequently integrating ESG into the investment process, but rarely adjusting their models based on ESG data.
- The main drivers of ESG integration are risk management and client demand.
- The main barriers to ESG integration are a limited understanding of ESG issues and a lack of comparable ESG data.
- Investors acknowledge that ESG data have come a long way, but advances in quality and comparability of data still have a long way to go.
- It would be helpful for issuers and investors to agree upon a single ESG reporting standard that could streamline the data collection process and produce more quality data.
- Many workshop participants were concerned that ESG mutual funds and ETFs offered to investors may be driven by marketing decisions and may not be true ESG investment products.
Top regional findings
The Arabian Gulf
- Islamic finance and ESG investing are complementary capital-raising and investment approaches with many shared principles, such as being a good steward to society and the environment. With many more similarities than differences, both offer products that serve Muslim and non-Muslim investors alike, and both possess strong practices and policies that each can learn from the other.
- Demand for ESG integration has largely come from outside the Arabian Gulf region. In terms of local investor demand for ESG, sovereign wealth funds were less focused on ESG compared to life insurance and pension investors.
- Integration of ESG factors is predominantly happening in the equity space. ESG is not talked about much in the fixed income space, with investors asking more questions about yields than about sustainability.
- In France, corporate governance is currently the ESG issue most integrated into the investment process for both equities and bonds. However, survey responses suggest that by 2022, environmental factors will overtake governance as the issue most affecting equities and corporate bonds.
- As is the case in most other markets, client demand and risk management are driving ESG integration, although respondents see regulation around ESG integration and reporting as a greater influence in France than in other markets.
- Respondents see the limited understanding of ESG issues and concerns about the investment benefits of ESG integration as the main barriers to ESG integration in France.
- Respondents see the impact of ESG issues on the prices of equities and bond yields as lower in Germany than in the other EMEA markets we visited, although these numbers increase substantially when we asked survey respondents how they feel ESG issues will affect share prices and bond yields by 2022.
- Many firms in Germany are at the start of ESG integration. They have a relatively low level of ESG integration, but it is likely to grow. German firms often use screening as a form of integration.
- The main barriers to ESG integration in Germany are a lack of comparable and historical data and a limited understanding of ESG issues.
- ESG integration is more developed in the Netherlands compared to most other markets, with the use of integration and of impact investing both growing.
- Although nearly two-thirds of survey respondents in the Netherlands feel that governance issues often or always affect equity prices today, only about one-third believe the same of environmental and social issues. Over two-thirds of respondents feel that environmental and social factors will often or always impact equity prices by 2022.
- Risk management is the top driver of ESG integration in the Netherlands for equities, but alpha generation is a close second, signaling the Dutch position as a leader in ESG integration.
- Equity practitioners adjust their valuation models and tools for material ESG issues more frequently than do fixed income practitioners. Equity practitioners integrate governance factors only slightly more frequently than environmental and social factors, while fixed income practitioners integrate environmental, social, and governance factors with identical frequency.
- Many Swiss workshop participants focused on the reality that the materiality of ESG issues is more likely to become evident over the long term. They look at ESG issues through a long-term investing lens.
- Although the most-cited barrier to ESG integration is a limited understanding of ESG issues and ESG integration, a number of participants noted that it would be helpful to have a universal framework to understand what investors are calling “ESG factors” and “traditional factors.” A lack of investment company culture around ESG integration is the second strongest barrier to ESG integration.
- The UK is one of the most advanced markets concerning ESG integration in the investment process. However, survey respondents signalled that corporate governance issues are much more systematically included in the investment process than are environmental or social issues.
- Survey respondents expect that environmental and social factors will be systematically incorporated into the investment process at about twice the current rate by 2022.
- A lack of comparable historical data, a limited understanding of ESG issues, and a lack of company culture at investment firms are some of the main barriers to ESG integration in the UK.
- Local investors consider ESG factors in their investment analysis. However, little knowledge is available in the Russian market about what ESG integration entails. ESG integration is often confused with screening out sectors, companies, or products.
- Some Russian investors recently started to receive ESG questions from their foreign clients. Low client demand has been rated a top barrier to ESG integration by Russia-based survey respondents.
- Stakeholders involved in this study were in consensus that in Russia, the promotion of ESG investing could only work from a top-down approach, that is, the regulator will need to support this direction.
- Governance issues are systematically incorporated into the investment process for equities and corporate bonds more than 50 percent of the time, but social and environmental issues are incorporated in similar ways only about 25 percent of the time. Survey respondents feel that environmental and social factors will be incorporated into equity values and bond yields more than 60 percent of the time by 2022.
- Based on our survey and conversations with workshop participants, social factors appear to be incorporated into the investment process in South Africa more than in other markets we visited.
- Regulation drives ESG integration in South Arica more than in other markets, as South Africa’s listing standards and government regulations are more explicit about ESG disclosure requirements than are those in other markets.
Markets where the 23 ESG workshops were held:
- AMER: Brazil; Canada; and US.
- APAC: Australia; China; Hong Kong; India; Japan; and Singapore.
- EMEA: France; Germany; Netherlands; Russia; South Africa; Switzerland; UAE; and UK.