NOVEMBER 20, 2020

Utilising ESG within sustainable investment process

Gert-Jan Hoogendoorn

Client Solution Director

Reading time: 2 min


Accelerated Growth and Allocation

ESG investing has accelerated in the current COVID-19 Pandemic period. While ESG has been around for many years, the attention to ESG investing has now come to the surface for a wider audience. The European Green Deal and Climate change awareness are both factors that created a new perspective on investing, where ESG is either added as an additional risk metric or is used to be compliant with the client’s sustainability preferences. Due to these reasons, it is evident that ESG investing will accelerate as investors continue to reallocate assets with ESG needs and objectives in mind.

Data Providers

Data providers such as Sustainalytics, Refinitiv and Confluence have had their own ESG methods and frameworks in place for several years and the quality of the scores is increasing. However, due to the lack of global standards from regulators, the ESG landscape for data providers is fragmented with every provider using their own methods.

Score or Ratings

ESG scores or ESG ratings can be interpreted on a factual or estimated basis. Rating based on estimated basis have a reduced lag due to the impact of actual current affairs. ESG scores are normally calculated from low to high where high is better, whereas ESG ratings are conceptually in the domain of risk, where a lower rating is less risk.
To eliminate the downside of the factual basis, a momentum or controversy score has been introduced by most data providers. This controversy score calculation differs per provider but aims to use public sources to indicate, for the various ESG categories, whether any controversy has recently been found.

Peer and Industry Comparison

To allow for comparisons between companies, the ESG ratings or scores are also used to off-set against peer groups or industry. However, industries face different levels of ESG risk, and therefore divergence can be very significant. In addition, the level of granularity on ESG varies per provider. Due to the above factors, a careful selection process of the data providers is advised, depending on the needs of the CIO and policies used by the financial institution.
In summary, the availability of industry exposure and/or peer group analysis is key to use in stock selection within sectors where ESG risk is part of the process.

ESG vs Sharp Ratio

In Portfolio Management, the ESG investing policy can be correlated to the sharp ratio of the portfolio. Not in all cases, but for companies that have ESG on their agenda and work towards a better ESG score or a lower ESG rating, these companies are likely to aim for a sustainable growth. This can lead to a positive factor in the development of the stock price and valuation of these companies, that can then lead to a better sharp ratio.

If you want to learn more about this topic, join our Webinar “Risk & ESG-aligned portfolios. The new frontier in investment strategies” that will take place on November 26th.

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