Ch. 8 ESG Integration and MGMT Flashcards
The endgame for ESG integration is
the combination of underlying ESG analysis to produce a more complete picture of ESG exposure and risk at the portfolio construction and management levels.
Exposure, risk, perf attribution, HL AA decision
misperceptions when applying ESG at the portfolio
level. Accordingly, this chapter will attempt to address the following questions:
- How can we characterise interest and demand for investment strategies in this area?
- What exactly do we mean by ‘ESG strategies’, and how can we understand this approach within the broader language of responsible investment?
- What are the assumptions underlying the claim for alpha generation and how can we extend them to include portfolio management and construction more generally?
often conflate the terminology of
‘responsible investment’. they rarely, if ever, compete against one another
Exclusion, esg (stewardship), impact
as per mercer report - which AC has highest and lowest level of progression on esg
high - infra
low - HF
Review Fig 8.2 +8.1
as per mercer report - which AC has highest and lowest level of strategy availability of sustanability themed strategies
High - Infr/ RE
Low - HF/FI/ RE
Review Fig 8.2 +8.1
Analysts need to justify their views in ‘a story’ or ‘investment thesis’ of
a security, this includes
▶ the intrinsic value of the security;
▶ credit analysis;
▶ the potential for a rerating or derating in valuation;
▶ potential risks;
▶ short-term and long-term catalysts; and
▶ an expectation on the security’s earnings growth and cash flow profile.
The role of portfolio managers, on the other hand, is of much broader scope. A portfolio manager constructs
and manages a portfolio through a careful process that aggregates all of the individual, underlying risks. And
while portfolio managers often form their own views-
role is to weigh securityspecific conviction against: ▶ macro- and micro-economic data; ▶ portfolio exposure; and ▶ sensitivities to potential shocks.
To this end, the ESG framework should illustrate a continuity from micro- to macro-forms of analysis, including:
▶ the organising principles and methodologies for ESG analysis;
▶ the identification and analysis of financial and non-financial (ESG) materiality at the individual security level;
▶ the approaches to build a composite picture of risks and exposure at a single portfolio level; and
▶ the representation of ESG risks and exposure that informs a mixed asset strategy which may include many
different, underlying strategies.
ESG integration can focus on risks as well as opportunities. A bias towards looking at one of these can lead to…
different return profiles at the portfolio level as the emphasis can shift from downside protection to upside
participation.
ESG integration should be considered in light of two approaches
discretionary (typically fundamental) and quantitative (screening)
investment strategies.
Broadly speaking, ESG external research and analysis can be categorised between…
academic research and
practitioner research. Each of these resources offers their own unique advantages and disadvantages for
investors.
Accedmeic vs practitioner
academic studies on an individual basis
often end up disconnected from practice and are not widely or generally applicable - good for discussion and general trends cross regional.
Practitioner
research, on the other hand, is often less rigorous than academic work, and tends to be less conservative in its
assertion to correlate ESG with investment returns, sometimes ignoring other causal factors at play.
Including:
▶ sell-side research and analysis;
▶ academic studies;
▶ investment consultant research;
▶ third-party ESG data provider research;
▶ ESG-integrated fund distribution platforms;
▶ asset owner and asset manager white papers;
▶ investor initiative research;
▶ non-governmental organisations (NGOs) research;
▶ governmental agencies and central banks; and
▶ multilateral institutions and agencies.
Portfolio managers may now treat carbon exposure on a portfolio-weighted basis (instead of company or per asset) as per the reco from TCFD. WACIM…
Weighted-average carbon intensity measures a portfolio’s exposure to carbonintensive
companies on a position-weighted carbon exposure.
Calculated as the carbon intensity (Scope 1 + 2 Emissions ÷ US$ million revenues) weighted for each position within a portfolio, this metric can be employed
by investors to tilt or overlay portfolios towards lower-carbon exposure.
organise exclusions across four basis categories:
▶ universal;
▶ conduct-related;
▶ faith-based; and
▶ idiosyncratic exclusions.
Universal exclusions represent…
exclusions supported by global norms and conventions like those
from the UN and the World Health Organization (WHO). It could be argued that controversial arms and munitions (cluster munitions and anti-personnel mines), nuclear weapons, tobacco and varying degrees of exposure to coal-based power generation or extraction all qualify as universally accepted given normative support and the growing asset owner AUM they represent.
examples on pg. 352
Conduct-related exclusions are generally…
ompany or country specific, and often not a statement against the nature of the business itself
Faith-based exclusions are specific…
to religious institutional or individual investors
Idiosyncratic exclusions are exclusions that are not…
supported by global consensus. For example, New Zealand’s pension funds are singularly bound by statutory law to exclude companies involved in the
processing of whale meat products
Exclusionary preferences are most commonly adopted and applied by…
asset owners rather than asset
managers.
investors often assume..
a best efforts approach in these cases as some issues continue to remain difficult to reconcile from a screening perspective
Another challenge is the treatment of asset classes and securities that…
outside of the traditional spectrum
of responsible investment, which has generally been focused on:
▶ listed equities;
▶ listed corporate debt; and
▶ real assets.
Quasi ESG Factors - compare highest vs lowest rated funds
Highest - size (large) - ROE - P/E - growth - Value - P/B - Quality - Momentum - Price momentum - Low volatility LOW
This is MCI (sustainalytics could be differnt)
The linkage between quality and ESG as factors stems…
from the intuition that the governance of higher ESG-rated companies drives stronger decision-making around capital allocation and shareholder returns.
what exactly is ESG?
If it can be quantified or measured, is it simply an amalgam of other established factors, like size and quality?
Linkage from ESG to Large size
ransparency bias towards large companies favours ESG because a common characteristic of high-ranking ESG companies is strong transparency and disclosure. Large companies, not surprisingly, are better equipped and staffed to address these issues, resulting in higher ESG
scores.
One of the most exciting, yet least developed, areas in ESG integration is the
degree and means to which it can
inform and shape the strategic asset allocation decision-making process and is the single most important top down decision (90% of variability of returns)
ESG is most commonly
integrated at the…
security level, complemented by more recent, increasingly sophisticated efforts to express ESG risk at a composite portfolio level.
