ESG integration is the explicit inclusion of ESG risks and opportunities into traditional financial analysis and investment decisions based on a systematic process and appropriate research sources. In other words, it refers to considering material ESG issues in addition to other traditional financial metrics when building a portfolio.
This approach puts an equal weight on each component of ESG. Environmental issues such as carbon emissions are as important as social issues like labor relations. The essence of ESG integration is to consider material ESG issues that are expected to affect a company’s performance. It is in line with the portfolio selection process of identifying any material information that can have potential impact, ranging from accounting disclosures to ESG issues. Many investors are already integrating ESG informally without realizing it.
In order to assess material ESG issues, portfolio managers and their team must conduct comprehensive research and identify issues that impact returns. ESG Integration adds another layer to the already extensive research undertaken when investing. Inovestor offers ESG data, powered by Sustainalytics, that help minimize the time and effort required to integrate material ESG issues. We provide a breakdown of the ESG Risk Rating, Notable Material ESG Issues, Product Involvement and a list of Controversies on over 12,000 companies worldwide.
Implementation
The Principle for Responsible Investment (PRI) outlines four stages of the integration model:
- Qualitative analysis
Investors collect and identify pertinent information from company reports or third-party investment research.
- Quantitative analysis
Investors analyze material financial information and adjust their financial forecasts and/or valuation models appropriately.
- Investment decision
From steps 1 and 2, a decision to overweight, hold or underweight the securities is made.
- Active ownership assessment
Investors can use their qualitative and quantitative analysis to initiate or support company engagements and/or inform voting.
Illustration
We applied quantitative screens using InoAdvisor’s screener to get fundamentally sound TSX-listed companies with stable or growing dividends over the past year. Using the SG overlay, we applied a qualitative screen to filter low E/S/G risk score.
Here are the filters applied:
- Market capitalization of $100 million or above,
- Sales of $10 billion or more,
- Dividend Yield of 1.5% or above,
- Stable or growing 1Y Dividend yield,
- Positive EPS,
- Stable or growing 1Y EPS,
- Stable or growing 2Y EPS,
- Net Operating Profit of $10 million or above,
- Stable or growing 1Y Net Operating Profit,
- Stable or growing 2Y Net Operating Profit,
- Economic Performance Index (EPI) of 1 or above,
- Environmental Risk Score of less than 10,
- Governance Risk Score of less than 10 and
- Social Risk Score of less than 10.
Unsurprisingly, the screen is composed mostly of financial companies. Banks and Insurance companies tend to have good fundamentals and low ESG risk due to the nature of their business. They have been early adopters of sustainability principles.
For a list of this screen, click here. Contact your account executive if you are not already subscribed to our new ESG add-on.
Power Corporation of Canada stands out. It has the highest dividend yield and lowest ESG Risk Rating from the screen. Its Economic Performance Index of 1.53 implies that the Return on Capital is 1.53 times the Cost of Capital.
From its 2020 Annual Report, Power Corp has been very active in the Sustainability space. It has been a signatory to the United Nations Global Compact since 2014 and contributes to the Sustainable Development Goals (SGDs). Power Corporation was one of the only three Canadian companies to receive the Top score of A (Leadership) of the CDP, a non-for-profit charity that runs the global disclosure system for investors, companies, cities, states and regions to manage their environmental impacts, in 2020.
