Environmental, social and governance investing has become a key topic among investors in recent times.
It is increasingly clear that the world is faced with significant long-term challenges, such as climate change, and that asset owners and asset managers have a role to play in helping to address these.
Investors are increasingly demanding their investments are managed in a responsible way, and ESG makes sense to integrate as it adds value.
Contrary to many other facets of the asset management industry, there is no common or formulaic approach when it comes to ESG.
Solutions offered by asset managers can vary widely.For some, the sole focus is on avoiding stocks in controversial sectors or attempting to beat an ESG benchmark.
We believe we have to go beyond that.
- Fund managers have a role to play in climate change
- Assessing ESG credentials is a skilful business
- ESG factors have an impact on performance
We firmly believe that ESG data (qualitative or quantitative) can add value for the fundamental investment case.
ESG can represent both important risks and opportunities for the individual investment case that traditional fundamental analysis might not uncover.
As fundamental investors, our time is spent analysing business fundamentals such as cash flow statements and balance sheets, as well as industry trends in order to identify ‘alpha opportunities’ – opportunities to buy good companies below their intrinsic value.
However, this alpha potential can evaporate quickly should an ESG-related risk materialise.
Recent examples include irresponsible supply chains for retailers, money laundering for banks and health and safety for metal and mining companies, to name a few.
As such, ESG should not be seen as a separate activity, but rather as a core pillar in the holistic analysis of a company.
Evaluating the data
In order to properly integrate ESG into the fundamental investment process, it is important to evaluate the ESG data on a company and industry in order to evaluate what is material for the investment case.
Once what is relevant and material is defined, one can then evaluate how this materiality should be reflected in an assessment of the company.
This is no simple exercise. There is a sea of ESG data, not all of which is relevant.
Furthermore, correlations between external rating agencies on the same companies are low – that is, little agreement on ESG merit.
This is very different to credit ratings for example, where the major credit agencies agree with almost perfect correlation in their ratings.
So, no simple exercise, and one that requires rolling up the sleeves and doing the work; whether assessing quantitative data or speaking with management and assessing qualitative data.
It is clear to us that doing the work to understand the ESG data and integrating it into your analysis can add enormous value.
The second important point is that the ESG data only gives a snapshot in time, just like the balance sheet of a company.