Ch 7 ESG Analysis Flashcards
7 reasons an investor may integrate ESG
A. meeting requirements under fiduciary duty or regulations;
B. meeting client and beneficiary demands;
C. lowering investment risk;
D. increasing investment returns;
E. giving investment professionals more tools and techniques to use in analysis;
F. improving the quality of engagement and stewardship activities; and
G. lowering reputational risk at a firm level and investment level
A. meeting requirements under fiduciary duty or regulations;
B. meeting client and beneficiary demands;
According to a 2017 CFA Institute
global ESG survey, 24% of equity investors, 55% of fixed income investors and between 79% and 92% of
alternative asset investors (across private equity, real estate, infrastructure and hedge funds) do not integrate
ESG into their processes. However, they must meet a certain level of integreation to meet the minimum demenads of a regulatory environment even if they do not beleive in ESG integreation ( EU)
Many investors seek to integrate ESG into investment processes to better
understand and lower investment
risk. Some also seek to enhance returns via ESG by seeking higher alpha. Recent surveys suggest that more
firms do so to lower the risk rather than enhance returns, but some firms do both
not all firms believe ESG
integration leads to better risk-adjusted returns. However
many ESG integration tools, such as scorecards, can be used to engage with company management teams and aid stewardship activities. These
same tools can also enhance the clarity of a company’s business model.
Qualitative ESG analysis is likely to be used in investment processes that are based on company-specific
research, fundamental analysis and stock-picking
A. Investment teams analyse ESG data to form their opinion on the ability of the firm to manage certain ESG issues.
B. They combine this opinion with their financial analysis by linking specific aspects of the company’s ESG risk
management strategy to different value drivers (such as costs, revenues, profits and capital expenditure
requirements).
C. Analysts and portfolio managers then seek to integrate their opinion in a quantified way in their financial
models by adjusting assumptions used in the model, such as growth, margins or costs of capital.
Quantitative ESG analysis is likely to be used in investment processes that use quant models to identify
attractive investment opportunities. In such cases,
the ESG data is typically aggregated into an ESG factor (an
ESG score), which is added to the quant models
ESG considerations could lead to adjustments to
▶ forecasted financials;
▶ valuation-model variables, such as cost of capital or terminal growth rates in discounted cash flow analysis;
▶ valuation multiples;
▶ forecasted financial ratios;
▶ internal credit assessments; and
▶ assumptions in qualitative or quantitative models
Reread ch 7 case studies
pg 26 -33
PE esg lacks
transparency and regulation of reporting - G is important (look to wework)
There are many hurdles and challenges for ESG integration. These include:
▶ Disclosure and data-related challenges, such as:
» data consistency;
» data scarcity;
» data incompleteness; and
» lack of audited data.
▶ comparability difficulties, such as:
» lack of comparability between ESG ratings agencies;
» comparing across different accounting and other standards;
» comparisons across geographies and cultures; and
» inconsistent use of jargon terminology.
▶ materiality and judgment challenges, such as:
» judgments that are difficult and uncertain; and
» judgments that are inconsistent.
▶ ESG integration challenges across asset classes:
» different types of assets and different strategies integrate ESG using different techniques
One of the most common criticisms of ESG investing is the difficulty for investors
to correctly identify, and
appropriately weigh, ESG factors in investment selection. Critics express concerns about the precision, validity
and reliability of ESG investment strategies
Criticism for ESG integration fall into 4 buckets
- Too inclusive of poor companies. ESG mutual funds and ETFs often hold investments in companies that may
be acknowledged as ‘bad actors’ in one or more of the ESG spaces. - Dubious assessment criteria. The criteria used for selecting ESG factors are too subjective and can reflect
narrow or conflicting ideological or political viewpoints. Non-material or socio-political factors may be overemphasised. Materiality assessments might be considered flawed. - Quality of data. The information used for selecting ESG factors often comes (unaudited or assured) from the
companies themselves. This complicates the ability to verify, compare and standardise this information. - Potential lack of emphasis of long-term improvements. Some financial advisers screen investments first for
performance and only after that for ESG factors. This initial emphasis on performance can exclude companies
with high ESG practices that focus on longer-term performance
The Sustainalytics’ ESG Risk Rating measures the degree to which a company’s economic value is at risk
driven by ESG factors
more technically speaking, the magnitude of a company’s unmanaged ESG risks.
Sustainalytics’ risk categories are
absolute
MSCI ESG Rating, ESG risks and opportunities are posed by:
▶ large scale trends (e.g. climate change, resource scarcity or demographic shifts); and
▶ the nature of the company’s operations.
