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.
Integrating environmental, social and governance (ESG) factors into analysis of listed equity investments is the most widespread responsible investment practice in the market today. Several drivers, including capital flowing into funds that integrate ESG factors and the growing awareness of academic research supporting the benefits, are encouraging more and more investors to practice ESG integration.
Download the full report
There are a range of techniques available to integrate ESG factors across investment strategies. Case studies demonstrate how they can be put to use, and that investors can treat ESG factors in the same way as any other financial factors using existing quantitative methodologies.
Investors can adjust forecasted financials (such as revenue, operating cost, asset book value and capital expenditure) or company valuation models (including the dividend discount model, the discounted cash flow model and adjusted present value model) for the expected impact of ESG factors.
Case studies from: Union Investment, Standard Life Investments, Alliance Trust Investments, ClearBridge Investments, RobecoSAM, Morgan Stanley Research, Trillium Asset Management, Sycomore Asset Management, RBC Global Asset Management, Caravel Management, MFS Investment Management, Robeco
Quant managers can construct models that integrate ESG factors alongside factors such as value, size, momentum, growth, and volatility.
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 portfoliosf ESG risk profile.
The overall ESG risk profile, or exposure to a particular ESG factor, of passive investments can be reduced by adjusting index constituent weights or by tracking an index that already does so.
Managers can integrate ESG factors into enhanced passive strategies as part of their investment decisions aimed at improving investment performance.
Sell-side analysts can generate ideas and investment themes for investment managers to integrate, or they can directly integrate ESG factors into fair values and investment recommendations (e.g. buy/hold/sell) themselves. In this fully integrated approach, sell-side analysts integrate ESG factors into their forecasted company financials (e.g. revenues, costs, asset, liabilities, tax rates – via the income statement, balance sheet and cash flow statement) and/or models (commonly the discounted cash flow model).
Insights from examples of existing ESG-integrated research are included for each approach.
Integration in financial forecasting phase
Economic analysis assesses the impact of ESG factors on the economy to adjust forecasted economic growth rates, and apply these to a company’s forecasted financials.
- Case study from: Citi
Value driver adjustment identifies an ESG factor(s) that is material to a particular sector, and integrates it into valuations and investment recommendations of companies across that sector.
- Case studies from: Credit Suisse, Barclays, Exane
Theme exposure explores which industries are associated with an ESG theme, and in turn which companies within it.
- Case studies from: Kepler Cheuvreux, HSBC, Bank of America Merrill Lynch, Kepler Cheuvreux, DZ Bank, CLSA
Integrated performance benchmarking allocates a score that reflects companies’ performance on ESG and other financial factors, absolute and relative to industry peers.
- Case study from: CLSA
Subject-specific benchmarking indicates potential disruptions to competitive positioning within individual sectors.
- Case study from: Societe Generale
Integration in company valuation model phase
Valuation model integration considers ESG factors when adjusting models that calculate a fair value/target price for a company.
- Case study from: Oddo Securities
Asset owners (or their investment consultants) assess external managers’ integration practices through their existing selection, appointment and monitoring (SAM) process in order to identify, hire and appraise managers that will be able to comprehensively meet their mandate.
Interviews with asset owners provide their insights on each stage of the process.
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 investment managers and even between teams. The first step, applicable to all investors, is to get senior management to buy in to the benefits of integrating ESG factors into investment processes.
Case study from: bcIMC
Integrating active ownership practices
A practical guide to ESG integration for equity investing
- Currently reading