The term “ESG integration” is often used when talking about ESG investing.

Practitioners new to ESG investing are sometimes uncertain what ESG integration is and how it is performed – so much so that they may not realise they are already performing integration techniques informally.

The PRI defines ESG integration as “the explicit and systematic inclusion of ESG issues in investment analysis and investment decisions.” Put another way, ESG integration is the analysis of all material factors in investment analysis and investment decisions, including environmental, social, and governance (ESG) factors.

 

Explore the full range of PRI resources on ESG integration across asset classes

It means that leading practitioners are:

  • analysing financial information and ESG information;
  • identifying material financial factors and ESG factors;
  • assessing the potential impact of material financial factors and ESG factors on economic, country, sector, and company performance; and
  • making investment decisions that include considerations of all material factors, including ESG factors.

It does not mean that:

  • certain sectors, countries, and companies are prohibited from investing;
  • traditional financial factors are ignored (e.g., interest risk is still a significant part of credit analysis);
  • every ESG issue for every company/issuer must be assessed and valued;
  • every investment decision is affected by ESG issues;
  • major changes to your investment process are necessary; and, finally and most importantly,
  • portfolio returns are sacrificed to perform ESG integration techniques.

Risk, return and opportunities

A key component of ESG integration is lowering risk and/or generating returns. Many investors have turned to ESG factors as another way to spot and attempt to avoid risk in an individual company or sector. Practitioners can also use ESG data to look for investment opportunities. For example, some practitioners analyse automotive companies to see how they are reacting to trends in car electrification and factor this assessment into their revenue forecasts. Another example is practitioners who invest in companies with strong ESG management that are likely to outperform in the long run.

Materiality

Another key component of ESG integration is materiality. ESG integration involves integrating only the material ESG issues that are considered highly likely to affect corporate performance and investment performance:

  • If ESG issues are considered material, an assessment of their impact is carried out.
  • If ESG issues are analysed and found not to be material, an assessment is not carried out.

The assessment of materiality requires an understanding of the top ESG issues affecting a particular country or sector. Practitioners collate ESG information from various sources – company reports, filings and websites, the internet, ESG research providers, and so on – to determine the most material ESG issues per company or sector. They then refer to and assess the list of material ESG issues for each investment, periodically reviewing the list for changes in material ESG issues.

 

Explore the full range of PRI resources on ESG integration across asset classes

 

The text above is taken from a joint PRI-CFA publication: ESG in equity analysis and credit analysis, available below: