.svg){kind=logo}
Philosophy: ESG integration as a financial opportunity and risk mitigation factor in the fundamental analysis
As long-term equity investors with a rigorous bottom-up security selection process, the Global Equity and Income team incorporates financially material environmental, social and governance (ESG) factors into its investment analysis and decision making. The team evaluates any ESG factors that could reasonably impact, both positively and negatively, the long-term economic value of a company. ESG integration is applied as an opportunity and risk mitigation factor in the fundamental analysis, thereby helping to improve the risk/reward profile of the investment strategies that the team manages. Identifying companies with improving ESG characteristics and avoiding companies with deteriorating EGS characteristics can be a source of alpha. As such, the team believes that the ESG trajectory of a company also matters to identify value for investors.
How ESG factors are integrated in the investment process
ESG integration in the bottom-up analysis
Every company subject to investment analysis is also evaluated on ESG factors that are financially material to the specific company. Generally, the relevant ESG factors are industry specific based on proprietary views from the investment team. ESG factors are uncovered through the team’s own research and engagements with companies in combination with external research providers such as Sustainalytics. High risk companies, including those with poor sustainability practices and rated low by external research providers, are subject to enhanced due diligence. ESG considerations are incorporated in the internal research reports, which are presented for debate and discussion at the team’s weekly meetings.
The team incorporates these ESG factors into long-term financial forecasts in the Discounted Cash Flow (DCF) valuations on a stock-by-stock basis. In practice, the ESG analysis can lead to adjustment in overall growth rate assumptions of revenue forecasts, operating costs forecasts, discount rates, and/or terminal value. For example, lower growth rates can be given to chemical companies for products that are likely to be banned on health and safety grounds or a terminal value of zero can be assigned to technology companies whose core products could be at risk of obsolescence. In other instances, the team may decrease operating costs of companies in the materials sector that deploy new clean technologies to reduce emissions and adjust operating costs for changes in labor costs and tax rates.
ESG integration in the investment decision making process
The bottom-up analysis leads an ESG score of strong, neutral or weak for each company. This score is then combined with the team’s fundamental company and industry-level research to arrive at a statistical confidence interval on the company reaching an intrinsic value target. This analysis drives the investment decision and ultimately portfolio weightings.
Company scores, both ESG and non-ESG, are maintained and updated through the team’s portfolio management platform. This tool provides a central depository of scores that can be challenged, reviewed and amended on an ongoing basis. These scores are reviewed while assessing financials and valuation models before making investment decisions. For example, for two securities with similar businesses and valuations, the team would buy or assign a higher weighting to the company with a better ESG score. Importantly, the team also values companies with improving ESG scores as these could be a source of alpha. In contrast, companies with deteriorating ESG scores are evaluated for a potential sell decision to avoid losses.
Engagement as a tool to be responsible active owners
The investment team are active owners and frequently engage with companies on ESG related issues as responsible investors. Engagement is both proactive and reactive, when appropriate. Proactive engagement is initiated internally whereby the team may choose to seek additional disclosures from companies in certain areas or engage with firms using best practices. Reactive engagement may be used to respond to reports of adverse ESG practices.
Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. The content of this document (including facts, views, opinions, recommendations, descriptions of or references to, products or securities) is not to be used or construed as investment advice, as an offer to sell or the solicitation of an offer to buy, or an endorsement, recommendation or sponsorship of any entity or security cited. Although we endeavor to ensure its accuracy and completeness, we assume no responsibility for any reliance upon it.