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 fixed income report. 

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The ESG integration framework

The ESG Integration Framework is not meant to illustrate the perfect ESG-integrated investment process. Rather, the ESG Integration Framework is meant to be a reference so that practitioners can analyze their peers’ ESG integration techniques and identify those techniques that are suitable for their own firm. We believe that this will be a useful resource and reference as you develop your ESG-integrated investment process over time. As every firm is unique, the ESG integration techniques of one firm are not necessarily the right techniques for all firms.

We recommend you refer to the ESG Integration Framework as you read the “Investment Practices of Local Practitioners” subsections of each regional report and the companion to this report, Guidance and Case Studies for ESG Integration: Equities and Fixed Income.

Research: the inner circle

Qualtative analysis 

  • Company questionnaires: Questionnaires sent to companies to collect more ESG data and information where the company’s level of public ESG disclosure is inadequate. These questionnaires are also used in parallel with regular company meetings, where investors and companies will meet to discuss the most material ESG issues.
  • Red-flag indicators: Securities with high ESG risk are flagged in lists, research notes, dashboards, and databases.
  • Watch lists: Securities with high ESG risk are added to a watch list for regular monitoring.
  • Internal ESG research: Based on a variety of data sources, proprietary ESG research/views/scores are created for all securities in the portfolio and investment universe.
  • SWOT analysis: ESG factors are included in the traditional SWOT (strengths, weaknesses, opportunities, and threats) analysis.
  • Materiality framework: A materiality/sustainability framework is created that includes all the key ESG risks and opportunities for each sector/country. This framework is referred to when making investment decisions and is regularly updated.
  • ESG-integrated research note: Research notes/credit notes consist of traditional financial information and analysis and ESG information and analysis.
  • Centralized research dashboard: Traditional financial data and ESG data are kept on one platform (dashboard/database) so practitioners can analyze concurrently traditional financial factors and ESG factors.
  • ESG agenda at (committee) meetings: Investment teams (and possibly ESG teams/ specialists) have a dedicated ESG item on all agendas of investment team meetings. Committees meet to discuss ESG strategy, ESG performance of portfolios, and/or controversial securities

Active ownership

  • Voting: This structured process captures all voting rights and applies a rigorous analysis to management and shareholder resolutions before casting votes. In addition to being used for voting, this process can be employed to submit resolutions on which other shareholders may vote.
  • Individual/collaborative engagement: Engagement captures any interactions between the investor and current or potential investee companies on ESG issues and relevant strategies, with the goal of improving (or identifying the need to influence) ESG practices and/or improving ESG disclosure. It involves a structured process that includes dialogue and continuously monitoring companies. These interactions might be conducted individually or jointly with other investors.

Security level: the middle circle

Security valuation - equities

  • Forecasted financials: Adjustments are made to forecasted financials (e.g., revenue, operating cost, asset book value, capital expenditure) for the expected impact of ESG factors.
  • Valuation-model variables: Adjustments are made to valuation-model variables (e.g., discount rates, perpetuity growth, terminal value) for the expected impact of ESG factors.
  • Valuation multiples: Adjustments are made to valuation multiples to calculate “ESG-integrated” valuation multiples. These multiples are then used to calculate the value of securities.
  • Forecasted financial ratios: Forecasted financials and future cash flow estimates are adjusted for ESG analysis and the effect on financial ratios is assessed.
  • Security sensitivity/scenario analysis: Adjustments are made to variables (sensitivity analysis) and different ESG scenarios (scenario analysis) are applied to valuation models to compare the difference between the base-case security valuation and the ESG-integrated security valuation.

Security valuation - fixed income

  • Credit analysis
    • Internal credit assessments: ESG analysis is used to adjust the internal credit assessments of issuers.
    • Forecasted financials and ratios: Forecasted financials and future cash flow estimates are adjusted for ESG analysis and the effect on financial ratios is assessed.
    • Relative ranking: ESG analysis impacts the ranking of an issuer relative to a chosen peer group.
  • Relative value analysis/spread analysis: An issuer’s ESG bond spreads and its relative value versus those of its sector peers are analyzed to find out if all risk factors are priced in.
  • Duration analysis: The impact of ESG issues on bonds of an issuer with different durations/maturities is analyzed.
  • Security sensitivity/scenario analysis: Adjustments to variables (sensitivity analysis) and different ESG scenarios (scenario analysis) are applied to valuation models to compare the difference between the base-case security valuation and the ESG-integrated security valuation.

Portfolio level: the outer circle

Risk management

  • ESG profile (versus benchmark): The ESG profile of portfolios is examined for securities with high ESG risks and assessed relative to the ESG profile of a benchmark.
  • Portfolio weightings: Adjustments are made to weightings of companies, sectors, countries, and/or currency in a portfolio to mitigate ESG risk exposures and avoid breaching ESG risk limits and other risk limits.
  • Portfolio scenario analysis: Different ESG scenarios are run to assess the impact of ESG factors on portfolio risk and return.

Portfolio construction

  • ESG profile (versus benchmark): The ESG profile of portfolios is examined for securities with high ESG risks and assessed relative to the ESG profile of a benchmark.
  • Portfolio weightings: Adjustments are made to weightings of companies, sectors, countries, and/or currency in a portfolio to mitigate ESG risk exposures and avoid breaching ESG risk limits and other risk limits.
  • Portfolio scenario analysis: Different ESG scenarios are run to assess the impact of ESG factors on portfolio risk and return.

Asset allocation

  • Strategic asset allocation: Strategic asset allocation (SAA) strategies factor in ESG objectives and analysis to progressively mitigate the ESG risks and enhance financial performance.
  • Tactical asset allocation: Tactical asset allocation (TAA) strategies factor in ESG objectives and analysis to mitigate short-term ESG risks.
  • Portfolio scenario analysis: Different ESG scenarios are run to assess the impact of ESG factors on SAA strategies and TAA strategies.