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Integrating ESG into the Investment Process

The increased interest in funds that comply with ESG principles has made integrating ESG into the investment process a key issue. ESG considerations need to be taken into account when evaluating sovereign bonds, corporate bonds and valuations, and pricing corporate actions.

Challenges with integrating ESG

Rating sovereign bonds’ ESG compliance means assessing the issuing country’s performance in following those principles, which can raise difficult moral and ethical questions. For example, should a firm refuse to buy a country’s bonds with an emerging economy that relies on fossil fuels? The country might not yet have the resources to become more environmentally friendly, and its atmosphere may suffer the effects of all the past emissions from developed nations. Avoiding the emerging economy’s bonds would also deny its support to become environmentally sustainable.

With corporate bonds, a challenge can be to accurately evaluate a company’s efforts to become sustainable. For example, how can an investor track an oil company’s progress toward green energy? Investors looking for data on a company to evaluate it as a suitable investment may wonder how ESG compliance or non-compliance could affect its valuation. Are the markets pricing it to reward an ESG effort or to reward cost-saving achieved by cutting corners on ESG principles?

Buy-side investment firms trying to standardize their data collection and distribution process could set out to build a repository for ESG data. However, if insufficient data gets into that repository due to lack of data sources, inaccuracies or flaws, it would be propagated to all users of the repository.

As it is, ESG compliance data is not purely financial data, and investors need a way to integrate that into their financial “stack.” Some sources of ESG data are unstructured, and the standards are immature. This means processing this data takes more time, which slows down investment and trading decisions. ESG data lacks the history of conventional pricing, corporate actions, and transactions.

So how can one evaluate ESG data and scores for securities in a portfolio?

Evaluating ESG data can be achieved in several ways, including portfolio comparisons, deep analysis of ESG scores, and comparisons between companies. This is in addition to emissions analytics and portfolio aggregations, company ESG metrics, portfolio screenings, and SFDR principal adverse impact (PAI) solutions.

Use cases to think about

When integrating ESG into the investment process, there are a number of typical use cases that firms are looking to run smoothly. These include:

  • Portfolio comparison – this review a portfolio’s aggregate ESG score and compare it to other portfolios across time. This helps users analyze contributors, assess the ESG efficiency of companies, see a ranking of ESG scores, and highlight specific effects.
  • ESG score “deep dive” analysis – compare a scoring metric across all data sources to create composite scores. This helps users choose types of scores or calculation methods and see detailed scores from a range of data providers ranked within industries and across time.
  • Company comparisons – compare detailed ESG data for all companies or a shortlist within a sector. This allows users compare companies on any ESG topic, and filter companies by specific data fields, such as the scope of their greenhouse gas emissions.
  • Company emissions analysis – looks at how different parts of the company impact emissions. This could include the company’s supply chain or how different income streams affect emissions.
  • Sovereign emissions analysis – is similar to the previous company emissions analysis but applies to countries issuing sovereign bonds as investments.
  • Portfolio aggregation of emissions – see values across portfolios and timeframes, as well as company-level breakdowns and the companies that have the lowest and highest emissions. Users can then correlate this data against the amount of investment in those companies.
  • Company ESG metrics – “deep dive” into ESG metrics for a company, from all data sources, including ESG scores, quantities, controversies, and raw ESG factors. Also drill into data contributing to scoring or rating algorithms.
  • Portfolio screening – check if a potential investment is suitable for an ESG portfolio. Get key details such as controversies, sanctions, or products that run afoul of ESG principles. This capability can filter data concerning extreme controversies as well as revenue being earned from a product that has issues with ESG principles.
  • SFDR principle adverse impact (PAI) – report PAI as required by the European disclosure regulation from available or estimated data. See the previous year’s numbers, then use a rules-based configuration that mimics the template set out in SFDR for reporting.

Investors can use these capabilities to evaluate companies and funds to make sure they meet any ESG requirements. GoldenSource ESG Impact can help – contact us to learn more

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