Portfolio managers and analysts are increasingly incorporating ESG factors into 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.
After extensive analysis of the ESG integration techniques of direct investors across the globe, CFA Institute and PRI collated the many ESG integration techniques used by practitioners and developed the ESG Integration Framework (see below). This article is taken from the Guidance and case studies for ESG integration: equities and ...
This report focuses on the current state of ESG integration in the Americas, with reports for EMEA and APAC are scheduled to be released in March 2019.
To guide investors – both asset owners and investment managers – who are implementing ESG integration techniques in their investment decisions and processes, this report is the most comprehensive description to date of what ESG-integrated analysis is, and how it works in practice.
Sell-side brokers integrate ESG information with traditional financial information – by leveraging their financial information systems, their access to company management, and the expertise of mainstream, sector-focused investment analysts – to improve research.
Fully integrating ESG factors into a new or existing investment process takes time and often requires trial and error. Many variables are involved and approaches differ between organisation and even between teams.
The first phase of active ownership involves reviewing the investor’s overall investment strategy, including the vision, mission and investment principles of the organisation.
The first step to identify targets for engagement is setting up regular monitoring of investee companies on ESG issues which represent value at risk or potential opportunities for long-term financial performance and impact on the real economy.
When investors decide to partially or fully outsource their active ownership activities to investment managers or specialised service providers, defining criteria to select, appoint and monitor third parties is crucial.
Transparency is a key component of active ownership and it forms part of many stewardship codes and principles (i.e. Principle 6, the ICGN Global Stewardship Principles, the OECD Responsible Business Conduct for Institutional Investor and several national stewardship codes).
The Collaboration Platform is a unique private forum that allows signatories to pool resources, share information and enhance their influence on ESG issues.
When integrating ESG factors into investment analysis, they are examined alongside other valuation drivers. It has been more common to process ESG factors through qualitative analysis, but investors are increasingly also quantifying and integrating ESG factors into financial forecasting and company valuation models, in alignment with other financial factors.
ESG integration has historically only been associated with fundamental strategies, but this perception is slowly changing as several quant managers are now integrating ESG factors into their valuation models and investment decisions.
In smart beta strategies, ESG factors and scores can be used as a weight in portfolio construction to create excess risk-adjusted returns, reduce downside risk and/or enhance portfolios’ ESG risk profile.
Some investors believe that as a manager cannot make active investment decisions in passive strategies, ESG factors cannot be integrated in passive investments as this may cause performance to deviate from the benchmark’s. Passive strategies can incorporate ESG factors, however.
Selecting an investment manager that can act in accordance with an asset owner’s investment preferences requires thorough due diligence of the manager’s investment approach and performance, investment process, stock selection and portfolio construction decisions.
Once the most eligible asset manager is selected, asset owners can include ESG terms in the investment management agreement (IMA) to formalise their expectations.
To review investment performance and managers’ integration practices, asset owners: organise periodic monitoring meetings with investment managers; ask them to complete questionnaires/regularly report; and/or use methods such as peer analysis, internal scoring systems and portfolio analytic tools.