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Why ESG integration can be a powerful tool for your investment performance. 

The Principles for Responsible Investment (PRI) defines ESG Integration as "the explicit and systematic inclusion of ESG issues in investment analysis and investment decisions." 

In other words, using Environmental, Social and Governance data to influence our investment decisions.  

But first, a quick context check

ESG investing is actually a big of a misnomer.  

E, S & G actually refer to a type of data reporting that companies provide to financial analysts.

 

Companies are increasingly providing data around their:

  • Environmental

  • Social &

  • Governance impacts.  

Environmental

Energy Consumption

Pollution

Climate Change

Waste Production

Natural Resource Preservation

Animal Welfare

Social

Human Rights

Child and Forced Labor

Community Engagement

Health and Safety

Stakeholder Relations

Employee Relations

Governance

Quality of Management

Board Independence

Conflicts of Interest

Executive Compensation

Transparency and Disclosure

Shareholder Rights

All of this reported data is then summed up and computed by a number of different reporting companies so investment analysts can decide whether or not to add a particular company to their investment portfolio. 

 

A company's balance sheet or cash flows are governed by a standardized set of accounting practices.  

ESG data does not yet have a globally standardized set of accounting practices which makes the data a bit more subjective. 

 

This ESG data can give an investment analyst a different “lens” to view companies with.

ESG Integration vs ESG Screening

ESG Integration intends to select and modify the weighting of a portfolio based on relevant ESG information.

It is important to know that ESG integration DOES NOT ban specific investments like a values based or socially responsible portfolio. 

ESG Screening on the other hand starts with SCREENING OUT (exclusionary) investments in particular categories. 

Think of it this way...

Traditional Investment

No adjustments in the weightings of a portfolio based on a company's environmental, social or governance ratings. 

ESG Integrated

All investments are still available, but company's with poor ESG data are under-weighted and companies with superior ESG data are over-weighted

ESG Screened

Companies with poor ESG data or companies in certain sectors are eliminated from all investments. 

Why this is important to you

1) For starters, the fact that you're reading this article most likely means that Environmental, Social and Governance concerns are important to you. 

2) There are potential risk and reward benefits to ESG Integration.

3) I believe that companies who are leaders in the various E S & G metrics will be the biggest leaders of the future.  

Let's dig in a bit further

1) ESG Integration and your values

What you do with your money, your financial decisions, those are very personal things. 

How we spend our money tends to carry a lot of meaning to us. 

With the growing political division, racial inequality and corporate scandals, it is becoming increasingly important to take a stand for what you believe in. 

Choosing to bring your investments closer in alignment with your values is a good step and can help you to feel more financially empowered. 

2) The Potential Risk and Reward benefits to ESG Integration 

We'll spend a little more time here since I think this is critically important. For a more in depth article, check out this one.  

The addition of ESG integration allows analysts to look at a company "beyond the numbers."  

Reviewing a company's Environmental, Social and Governance practices can allow an analyst to look for some of the less traditional risks.  

It is relatively easy to analyze a company to see if they are profitable and how those profits may be expected to grow over time. It is much more difficult to determine if a company may be exposed to risks such as:

  • Environmental disasters > Ex. British Petroleum

  • Targeting minorities with deceptive practices (Social) > Ex. The University of Phoenix (Apollo Group)

  • Fraud (Governance) > Ex. Volkswagen and Wells Fargo

While you can never entirely eliminate intentional deceit or corruption, analyzing a company with additional ESG criteria can provide a different picture when looking to make an investment.

 

This deeper look can potentially be a way to decrease your portfolios exposure to certain risks.  

In addition to the potential to reduce risk and have a portfolio with lower earnings volatility1, a number of studies have shown that ESG Integration can add additional performance

At worse, it appears that ESG integration does not create any additional negative effects on a portfolio. 

A survey by Deutsche Bank’s Asset and Wealth Management division in conjunction with the University of Hamburg looked at the entire universe of 2,250 academic studies published on the subject since 1970. 

 

It concluded that ESG made a positive contribution to corporate financial performance in 62.6% of meta-studies and produced negative results in only 10% of cases (the remainder were neutral).2

3) Companies who are leaders in E, S & G metrics may be the leaders of the future

Increasingly our personal values are becoming a central part of our investment decisions. 

Record numbers of dollars have flowed into sustainable investments over the last few years and according to a recent Deloitte study3, 

"ESG Mandated assets in the United States could grow almost three times as fast as non ESG mandated assets to comprise half of all professionally managed investments by 2025"

While there is no guarantee of future return, I think the trends are pretty clear. 

There is (and has been) a new wave of investing that is becoming more and more mainstream.

I would encourage you not to think of ESG Integration as a new way of investing, but more of a natural evolution in the way we invest. 

Think of how we used to make purchases in the past compared to how we do today. 

The internet and Amazon have changed the way we make purchases because we can more easily compare products and more importantly customer reviews. 

We now have more data (through the ease of the internet) and access to more subjective data (product reviews) that help us to make better (and more confident) purchasing decisions. 

This is exactly what ESG data provides.

Most of us wouldn't think of making a major purchase without researching and reading reviews. 

 

Why not make your investment decisions the same way? 

If you want to talk more about ESG Integration, but don't know how to get started feel free to schedule a phone call.  We're happy to help...

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