Incorporating Environmental, Social, and Governance (ESG) Analysis into the Investment Process

While the core of a CFA Program Candidate Body of Knowledge remains stable from year to year, over time candidates and members will discern incremental change.  The evolution of the global investment industry is inevitable, and the body of knowledge must develop to reflect those changes.  Anyone paying attention to the development of the CFA Program curriculum over the past decade will notice the relatively new inclusion of environmental, social, and governance (ESG) readings.  That’s because more and more analysts and investors are factoring into the investment process issues that may lie outside a company’s financial statements.

For example, some analysts and investors had shied away from investing in BP and Tepco in recent years due to environmental and/or safety concerns. These individuals weren’t clairvoyant — their analysis simply led them to identify potential red flags at these companies and avoid a pothole in their portfolios.

Analysis of economies in the Middle East that married socio-economic trends and demographic analysis with an understanding of political and social issues in these markets may not have predicted the recent revolutions in some Middle Eastern countries to the date, but such an examination could have shown an investor that tectonic changes were more likely than they had been in decades.

As far as governance is concerned, activist investors have used market inefficiencies based on corporate governance for years to unlock value at companies with poor governance practices. Just think of your favorite (or least favorite) corporate raider or activist investor and the campaigns around issues from poison pills in the ‘80s having an opportunity to “say on pay” today.

An introduction to these issues exists for anyone interested in the CFA Institute publication Environmental, Social, and Governance Factors at Listed Companies: A Manual for Investors.

Below are two additional practical examples from our “Take 15” video series, in which we speak to experts on these issues to better understand how investors use ESG information:

• The first is a recent interview with Michelle Clayman, CFA, the founder, managing partner, and CIO of New Amsterdam Partners, who discusses incorporating nonfinancial ESG data in the investment process.
• The second is a discussion with Curtis Ravenel, global head of sustainability initiatives at Bloomberg LLP, who speaks to how his team is collecting and organizing ESG data to meet the demands of customers increasingly using this information when investing.

Is analysis that incorporates ESG here to stay? Should it be a requirement to fulfill fiduciary responsibilities? Your comments are welcome.