ESG implementation strategies vary widely across asset owner types, as I explained in “Does ESG Matter?” But it is important to bear in mind that integration is itself a broadly defined category, with varying degrees of systematic processes used across different industry participants.
For example, the pan-European stakeholder network Eurosif has noted the growing prevalence of less structured integration among European asset managers, whereby separate analysts are employed to focus exclusively on ESG factors and share their views with mainstream portfolio management teams.
Addressing ESG factors through this type of fragmented team structure may be useful in more explicitly demonstrating a manager’s ESG focus to clients and prospects, but its effectiveness from a holistic company analysis perspective is debatable. The isolation of the ESG function that is implicit in separate team structures may, ironically, make it more difficult to achieve seamless integration.
Integrating sustainability and governance considerations into traditional analysis is becoming more appealing as investors realize that many elements of ESG are inextricably linked with company quality.
Integrating sustainability and governance considerations into traditional analysis is becoming more appealing as investors realize that many elements of ESG are inextricably linked with company quality. The increasing prevalence of sustainable growth investment themes, and their impact on future earnings prospects for companies across a range of industries, has contributed to a more implicit incorporation of ESG into investment decisions.
An automotive components research analyst, for example, needs to understand the implications of vehicle safety, efficiency, and automation trends for future order book growth and profit margins. As highlighted in my previous commentary on sustainable growth themes, these themes are naturally facilitating more cross-sector collaboration among asset management teams. Similarly, with respect to autos, the emergence of innovative vehicle technologies such as advanced driver assistance systems (ADAS) is altering the return profile and competitive dynamics for the semiconductor industry.
Achieving ESG portfolio integration in a systematic way has been complicated by a lack of corporate disclosure and poor data quality. The wide variation in sustainability reporting and disclosure practices across geographies and market capitalizations (i.e., companies based in emerging markets tend to report less than developed market counterparts, while small and midsize enterprises have fewer resources to produce glossy corporate social responsibility reports).
This has historically translated into weaker global universe coverage by ESG ratings providers and traditional research firms. The tide is turning, however, as more companies are being required by asset owners and regulators to report on ESG factors.
Reporting standardization initiatives are working to help overcome portfolio integration obstacles.
Reporting standardization initiatives are working to help overcome portfolio integration obstacles. SASB, the Global Reporting Initiative (GRI), the International Integrated Reporting Council (IIRC), the Carbon Disclosure Project, and others are seeking to advance corporate disclosure on sustainability issues. The challenge is related more to the quality of reporting rather than the quantity: According to the GRI, from 2005 to 2015 the number of companies issuing sustainability reports increased nearly 13 times, from 436 to 5,634.
Governments and stock exchanges are also playing a bigger role in mandating reporting and seeking to improve reporting quality. According to the nonprofit organization Ceres, there are approximately 180 laws and regulatory standards in 45 countries requiring some form of corporate sustainability reporting. From a stock-exchange perspective, investment banking firm CLSA notes that five major Asian exchanges will introduce reporting requirements in the next three years.
Importantly, there is a concerted effort between SASB, GRI, IIRC, and exchanges to streamline reporting and emphasize metrics that are most relevant to investors (i.e., those that have potential financial impact). We expect data quality to improve with these reporting initiatives, helping win over ESG skeptics and encourage broader integration adoption.
GICS Reclassification: Impact on Emerging Market Investors
