Views on improving the integrity of global capital markets
13 September 2018

Two New Reports Explore ESG Integration in Americas, and Offer Global Case Studies of ESG Integration

Posted In: ESG

Environmental, social, and governance (ESG) factors are increasingly being integrated in the investment process. A  2017 survey of CFA Institute members showed that 73% take ESG into account in their investment analysis and decisions. However, the survey also showed that many investors did not understand just what was meant by ESG integration or ESG investing and were seeking guidance on “how” to best integrate ESG factors in the investment process.

With this challenge in mind, CFA Institute and the Principles  of Responsible Investment (PRI) undertook a rather ambitious project: to travel around the world and talk to investors, analysts, and asset managers about ESG integration, with a goal of better understanding how ESG integration is and isn’t being done. We wanted to uncover the main drivers of and barriers to ESG integration, appreciate the differences in ESG integration practices around the world, and highlight best practices that could benefit investors just beginning to integrate ESG factors into their analysis.

After 23 meetings in financial centers around the world, we think we have a better understanding of ESG integration, what it is, what it isn’t, and how to do it well. The summary of our findings can be found in two new reports: ESG Integration in the Americas: Markets, Practices, and Data, and Guidance and Case Studies for ESG Integration: Equities and Fixed Income. We will be publishing reports on our findings in EMEA and APAC in late 2018 and early 2019, respectively.

As part of our efforts to better understand ESG integration, we surveyed 1,100 financial professionals (predominantly CFA members) around the world, ran 23 workshops in 17 countries, analyzed Bloomberg’s ESG company disclosure scores to better understand the current state of ESG disclosures, analyzed data from PRI’s reporting framework to better understand ESG investing practices in each market, and interviewed leading practitioners in each market to understand the current state of ESG integration.

Our main findings include the following points:

  1. There is no one “best way” to handle ESG integration.
  2. Governance is the ESG factor most investors are integrating into their process.
  3. Environmental and social factors are gaining acceptance, but from a low base.
  4. ESG integration is farther along in the equity world than in fixed income.
  5. Financial professionals are integrating ESG, but rarely adjust their models based on ESG data.
  6. Risk management and client demand are the main drivers of ESG integration.
  7. A limited understanding of ESG issues and a lack of comparable ESG data are the main barriers to ESG integration.
  8. ESG data has come a long way, but advances in quality and comparability of data are still a work in progress.
  9. A single ESG reporting standard would help streamline data collection and produce more quality data.
  10. ESG mutual funds and exchange-traded funds  may be driven by marketing concerns and not be true ESG investments.

It is important to understand that ESG integration is relatively new in the investment world; thus, no secret formula for ESG integration exists. Those who do ESG integration well have integrated ESG data into their existing investment processes, so to them ESG analysis is just one piece of a thorough fundamental analysis. Because there is no single agreed-upon definition of ESG or best practice for ESG integration, integrating ESG analysis into the investment process should be done in a manner that best fits each individual firm, its resources, and its clients.

ESG integration looks at risks and opportunities revealed by the analysis of environmental (E), social (S), and/or governance (G) issues that are material for a company or country. It is often more complex than negative screening, though a not insignificant minority of those we spoke to still think of ESG investing as simply a negative screen.

One of the main reasons firms undertake ESG analysis is to assess risk. However, the results of our survey and workshops show that few investors are looking at ESG analysis as a means of uncovering investing opportunities. Investors who can spot companies that are improving their E, S, or G profiles—before the larger market does—may be rewarded.

Investors should focus on ESG analysis, not ESG investing. ESG investing is often used as a marketing slogan, whereas ESG analysis is a fundamental part of investment analysis and requires a disciplined and tangible approach to be fully integrated into the investment process. In the long term, we expect the term “ESG investing” will fade away as ESG analysis becomes more accepted as simply a part of investment analysis.

Buyers should beware of products that claim to be ESG investment products. Many products marketed as ESG compliant or sustainable will define ESG differently and make different assumptions about what investments to include and what not to include. Investors need to do research when investing in anything called “ESG” or “sustainable,” to ensure they agree with the methodology behind those designations.

To date, one of the main drivers of ESG integration globally has been client demand, largely from institutional investors. Investors who want their asset managers to integrate ESG data into the investment process will have to demand it; when they do, asset managers are likely to respond. Likewise, investors who want better material ESG data from companies should also demand it.

Asset owners and asset managers should strive to do a better job of educating each other about how and why they integrate ESG data in the investment process. Clear communication by investors to their clients about ESG integration could do much to reduce the confusion and misperceptions surrounding what ESG integration involves.

Investors justifiably remain concerned with the quality, accuracy, and comparability of the ESG data they are using in their analyses. We are in the early days of ESG integration, and few standards and little verification are available with regard to ESG disclosures and ESG data. Thus, investors need to understand how robust, accurate, and comparable the data they are using are and adjust their analyses accordingly. In addition, investors and companies need to work together to agree on the reporting of material ESG issues and to promote the standardization of ESG data.

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Photo Credit: ©Getty Images/photo ephemera

About the Author(s)
Matt Orsagh, CFA, CIPM

Matt Orsagh, CFA, CIPM, is a senior director of capital markets policy at CFA Institute, where he focuses on corporate governance, ESG, and climate change analysis. He writes and speaks frequently on these topics on behalf of CFA Institute. His paper, Climate Change Analysis in the Investment Process was named “Best ESG Paper” by Savvy Investor in 2021.

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