Managing your clients' ESG expectations

The clear common denominator for all of these investment approaches is strongly tied to the moral obligation of ensuring the investments contribute to doing the ‘right thing’, but from the array of reporting and differing rankings, it is clear there is a divergence of what the ‘right thing’ might actually mean from one investor to another and when considering ‘performance’ with ESG as a measure, the correlation between the two, can be difficult to align.

Explaining the differing ESG investment management choices and decision-making processes  requires consideration of varying components under the headings:

Environmental - climate change, natural resources greenhouse gases, pollution, waste/environmental opportunities/management of natural resources.

Social - human capital/product liability/social opportunities.

Governance - corporate governance and board composition / corporate behaviour /diversity/politics.

In constructing an ESG portfolio, an investment manager will fully consider the risks and the quality of holdings through either internal scoring methodologies based on detailed analysis of a firm’s client base, supply chain and/or competitors, alongside potentially using external ESG benchmark indices. 

Benchmarks are constructed from independent third-party analysis that ultimately seeks to inform how firms who have measurable ESG factors, are performing.

The question often raised is: does this align with their interpretation of doing the ‘right thing’?

Rather than just a linear financial performance being analysed, the ESG overlay gives the investor financial performance data alongside an ESG grade, which would inform the investment decision for an investor.

The comparative difference here is that financial performance is measured on globally standardised accounting rules, whereas ESG scoring is presently not a standard methodology and can, to an extent, be considered subjective, but has been based on a robust well-constructed methodology in most cases, but not all.

Doing the 'right thing'

If a client sees an ESG score in their investment strategy advice, the question often raised is: does this align with their interpretation of doing the ‘right thing’?

There is a school of thought that companies with robust ESG practices embedded in their processes, in particular corporate governance, alongside good financial management, will lead to firms having better risk management embedded in their business and should therefore produce better performance.

If ESG scores are influenced by a factor that does not focus necessarily on environmental measures, it highlights the importance of just how an investor is able to measure ESG metrics that fully meet their own philanthropic and/or moral investment criteria.