Sustaining the momentum of responsible investing
Why do we believe in the benefits of integrating ESG information into the investment process? To us, it’s clear that environmental, social and governance issues impact share prices, corporate debt yields and spreads, as well as sovereign debt yields. ESG is relevant because it’s about the competitiveness of companies and as such has a long-term impact on the performance of investment portfolios.
Ultimately, the ambition of a responsible investment strategy is to contribute to a more sustainable global financial system in the interests of all stakeholders. To successfully integrate ESG, fund managers need to link the material longer-term issues to the value creation of the companies in which they invest. The central question is: how sustainable is a company’s value creation?
ESG integration means more than ‘just’ ensuring that these factors are embedded in the investment process.
“Our goal is to achieve better and more sustainable results by properly incorporating relevant ESG information at all levels of our investment process,” says Valentijn van Nieuwenhuijzen, Chief Investment Officer at NN Investment Partners. “The result is what we see as a more complete approach to investing, one that provides deeper insights whilst presenting an opportunity to improve the risk-reward balance.”
The UN Principles for Responsible Investment and the CFA Institute point at four steps underpinning practice leadership in ESG integration for both equities and credits:
- To analyse financial and ESG information
- Identify material financial and ESG factors
- Assess the potential impact of these factors on economic, country, sector, and company performance
- Take investment decisions that consider all material factors, including ESG criteria
The degree to which an asset manager includes these four activities in its investment decision-making process for all asset classes is what full ESG integration is about.
Embedded in ESG integration is the acceptance that ESG factors represent a core driver of both business value and risk. Undeniably, ESG integration is a broad church and there have been varying levels of progress. There are many misconceptions about ESG integration and its effect on market prices.
Some may confuse ESG integration with traditional negatively-screened ethical investment approaches that focus on excluding certain companies or industry segments. In reality, it is about common-sense investing; if anything, ESG integration is more about inclusion, rather than exclusion.
Investors’ thinking needs to progress
ESG integration shouldn’t stop at the analyst level but should also be part of portfolio construction. Given the significance of ESG information – particularly as a natural extension of financial investment analysis – this information needs to be ingrained in all phases of the investment process to capture its full potential.
By explicitly and systemically integrating ESG factors into the investment process we are better able to develop a complete understanding of the viability of the business model of a company. Combining ‘traditional’ financial analysis with ESG analysis can offer powerful insights in identifying attractively valued and better managed companies. Such a holistic perspective through the incorporation of ESG factors limits risks and at the same time improves the upside.
Analysis must not be limited by overly focusing on the lack of high-quality, consistent ESG data. Forward thinking investors should try linking the available sustainability data to the financial data to develop better insights. Instead of waiting for ESG data to become ‘perfect’, we better focus on the ‘right’ factors that give a better understanding of the value creation.
We see ESG information asymmetry as an opportunity in terms of the data we track, as well as how we bring it into our investment decision-making process. In doing so, we actively use the wealth of alternative ESG data and modern data collection techniques to add to our investment conviction. That way, ESG integration is not a barrier, but an enabler on the road to a sustainable future and attractive investment returns!
This communication is intended for MiFID professional investors only. Click “Read more” for the full disclaimer.