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Set ESG investing goals This blog is the second of a three-part series where we delve into an implementation framework to help you:

1) establish ESG investing goals,

2) uncover managers that align with your preferences, and

3) measure the outcomes that you expect.

The basis for evaluating and selecting asset managers for ESG investing are no different from those used for conventional evaluations: philosophy, process, and people. But to ensure your managers align well with your ESG investing goals, you’ll want to overlay ESG perspectives.

Philosophical Alignment

Understanding the extent to which a manager views the interaction between investment performance and non-financial performance as a tradeoff or a synergy is important. The expected time horizon for performance impact is also material. We capture these dimensions, “Doing Well,” “Doing Good” and “Biding Time” in Part 1 of this blog series.

Perhaps a manager places very little weight on ESG issues, deeming them immaterial or counterproductive over a short investment horizon. Conversely, ESG considerations might be central to a manager’s ethos, believing they’re a key source of alpha or risk management. Or, a manager might fall somewhere in the middle (Figure 1).

A manager’s core set of beliefs and principles that guide decision-making has always been vital in your evaluation process. Considering ESG managers is no different.

 

what does your ESG manager believe

 

Process Considerations

For any ESG investment process, asset managers aim to identify ESG issues that may create unexpected costs and those that create opportunities for a company. Both macro trends and company operations can affect ESG risks and opportunities:

  • What are the material ESG risks and opportunities the company faces?
  • What are the material ESG risks and opportunities for its industry?
  • How exposed is the company to these ESG issues?
  • How soon will these ESG issues materialize?
  • How well is the company managing those exposures?
  • How does the company compare to industry peers?

While managers are beginning to classify ESG risks and opportunities similarly, they’ll have very different views on how to define them or assess their impact. That’s no different from assessing financial data, really. You’ll want to find an investment process that’s most compatible with your non-financial preferences just as you would with traditional investment preferences.

Below are several process characteristics you should discuss with potential ESG managers to uncover that compatibility. We describe each in detail in our latest ESG paper, “What to Look for on the Road to ESG.”

 

process considerations bullets

Data Management, ESG Scoring, ESG Level or Change in Level, Sector Analysis, Regional Analysis, Active Risk Management, Security- or Portfolio-level Construction

People with Passion

Philosophy and process are essential in investing, but people make the difference at any asset manager.

Like traditional investing, ESG investing requires an examination of the people behind the philosophy and process. Asset owners must take a look at the intellectual capacity managers devote to ESG analysis to ensure managers aren’t merely “greenwashing.”

Intellectual capacity, however, doesn’t mean armies of people. ESG integration has been historically associated with traditional fundamental analysis, which tends to rely heavily on human capital.

But as ESG data becomes more available, quantitative managers who rely on algorithms to evaluate ESG elements and related investment opportunities are also becoming more prevalent. Intellectual capacity is not about numbers of people; it’s about people who’ve committed their craft to ESG investing.

As you review ESG managers, you’ll likely find that they demonstrate this commitment in one of three team structures: assimilate, renovate or separate (Figure 2). One structure isn’t necessarily better than another structure, and combinations of these exist too; all seek to get a comprehensive view of an investment’s risk and return potential.

 

ESG research models

Size Bias - Larger companies may receive better ESG reviews because they can dedicate greater resources to prepare and publish ESG disclosures, and control reputational risk. This can skew scores, rewarding large firms with higher ratings while penalizing those smaller companies with limited resources. Geography Bias - Higher ESG assessments for companies domiciled in regions with higher reporting requirements are another potential bias. For instance, a manager may positively bias an ESG analysis for a European-domiciled company, given the region’s stringent company disclosure requirements – a primary ESG data source. Industry Bias - Normalizing ESG reviews by industry is important given common systematic risks, but weighting those risks uniformly higher relative to company-specific risks can be a source of bias. Companies in the same industry may not operate similarly or respond to ESG issues equally. Normalizing analyses can oversimplify.

How Do You Monitor Results?

This blog post is the second of a three-part series where we examine an implementation framework to help you 1) establish ESG investing goals, 2) uncover managers that align with your preferences, and 3) measure the outcomes that you expect. For the complete implementation guide, download our most recent paper, “What to Look for on the Road to ESG.”  

What to Look for on the Road to ESG  ESG investing guide for decision-making. Download Paper

 

The views presented are for general informational purposes only and are not intended as investment advice, as an offer or solicitation of an offer to sell or buy, or as an endorsement, recommendation, or sponsorship of any company, security, advisory service, or fund. Nor do they purport to address the financial objectives or specific investment needs of any individual reader, investor, or organization. The views are subject to change at any time based upon market or other conditions, are current as of the date indicated, and may be superseded by subsequent market events or other conditions.

The information, analyses and/or opinions expressed are for general information only, and are not intended to provide any specific financial, economic, tax, legal, investment advice, or recommendations for any investor. It should not relied on as the sole basis for investment decisions. While every attempt is made to ensure that all information is accurate, there is no representation or warranty, express or implied, as to the accuracy and completeness of the statements or any information contained in this webcast. Any liability therefore (including in respect of direct, indirect, or consequential loss or damage) is expressly disclaimed. Past performance is no guarantee of future results. Investing involves risk, including fluctuation in value, the possible loss of principal, and total loss of investment.