Case study by Robeco
In January 2014, our Global Equity team started a review of ESG integration’s impact on their investment process and portfolios, to understand whether ESG factors are material: whether they affect company valuations and investment decisions resulting in a change to portfolio holdings. It was also important to demonstrate to our clients that we are integrating ESG factors, not just claiming to.
When valuing companies, we integrate ESG analysis right from the start, so to calculate the impact of ESG analysis on target prices we had to revisit our valuations and isolate the ESG element: we revalued a company without considering its ESG-related competitive advantages and disadvantages, and subtracted this from the target price reached when ESG analysis was integrated.
Categories of investment decisions
ESG factors’ impact on decision-making can happen at several stages of the investment process. Before we started recording investment decisions, we defined three categories (see below).
At the idea generation stage, ESG considerations can impact the decision of where to look in the first place, and whether or not to explore the idea further. For example, top-down screening on the ESG exposure of different markets made us look into exposure to recycling in metals recycling (Umicore) and medical waste (Stericycle) and exposure to car emission reduction in the IT, industrials, materials and consumer discretionary sectors. Bottom-up ESG performance (how a company is run) can also trigger further interest in a company (if positive or at an inflection point) or, when negative, lead us to dismiss it as fundamentally unattractive.
In the stock analysis/investment case phase, analysts’ decisions can have an impact without resulting in a change in the portfolio.
- We had several cases of increased conviction on current holdings as they scored well on the most material issues in their segment.
- We found stocks that were not in the portfolio and initially screened well, but turned out to have sources of negative ESG value, resulting in an unattractive valuation and hence not being recommended.
Alternatively, ESG considerations can affect decisions on holdings, thus impacting the portfolio construction phase.
During 2014 and the first two months of 2015, our Global Equity team produced 127 investment cases. In 52% of cases, ESG factors had an impact of company valuations, with adjustments ranging from -23% to +71%.
The most popular metric to adjust was profit margins (46% of all cases), followed by sales growth (35%) and the cost of capital (13%). Capex and working capital have been adjusted in just a few cases so far.
Over the same period, the Robeco NV Fund had 178 portfolio changes (90 additions, 88 reductions). In 28% of those cases, ESG considerations played a part, and in 9% they were a major factor. A third of the 28% that were affected by ESG considerations related to top-down ESG issues (such as trend exposures or segment views) and 71% to bottom-up considerations (individual factors or management quality). ESG factors affected considerably more buy decisions (two thirds of decisions with an ESG angle) than sell decisions (one third).
Our investment cases have given us a better view of what’s material per sector and how material such factors really are. By making ESG explicit in our valuation models, we are able to show ESG impact to our clients and more importantly, it helps to further boost awareness and discipline among our analysts and portfolio managers, even after five years of increasing ESG integration in our team.
Download the full report
A practical guide to ESG integration for equity investing