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Sep 23, 2015

ESG integration: implications for IROs

The traditional lines separating CSR, financial reporting and corporate governance are not as stark as they once were

Many asset managers now consider ESG factors across their whole portfolio

The growth of ESG integration into the investment decision-making process is a major development in asset management, and one that will likely lead to further changes in the IRO’s increasingly demanding role. Given the variety of issues in the ESG world, it helps to understand the changes taking place on the buy side so IROs can be prepared for the next step. 

In the early days of SRI, screening a portfolio to avoid exposure to certain sectors, such as tobacco or weapons, was generally the only available option. ESG integration is a newer development that assesses ESG factors across all portfolios, in order to measure risks and opportunities that traditional valuation models may not detect. It is described as a ‘best in class’ approach by many practitioners. 

While the practice is still relatively new, many asset owners now require their external managers to examine ESG factors as part of their investment process. In turn, asset managers are trying to integrate ESG by making sure headline ESG data, industry trends and company-specific research are available to every analyst and portfolio manager. 

The growth in ESG integration is evident in the number of signatories – 286 asset owners and 905 investment managers – to the Principles for Responsible Investment. The European Social Investment Forum also highlighted the rise in ESG integration in its most recent review, noting that three categories of ESG integration practices have been defined: ESG analysis is made available to mainstream analysts and fund managers and no formalized process exists; investors consider or include ESG analysis when rating or valuing investments; assets are subject to mandatory investment constraints based on findings from ESG research. Categories two and three are called ‘explicit’ and ‘systematic’ ESG integration. 

ESG integration is made possible by the growing amount of ESG data available to investors; by investment platforms such as FactSet and Style Research, which offer tools to help investors understand how ESG factors affect portfolio risk and performance; and by findings that ESG integration can help with stock selection and portfolio management. So how does this translate for issuers? The traditional lines separating CSR, financial reporting and corporate governance are not as stark as they once were. It seems likely the IR role will continue to evolve so that IROs can understand the language and trends concerning ESG integration and use these developments on behalf of their firms. 

These trends have also led to efforts to standardize the disclosure of ESG information by groups such as the Sustainability Accounting Standards Board, and to integrate material information about strategy, governance, performance and prospects from the International Integrated Reporting Council. These developments reinforce the need for IROs to continue to expand their remit. 

Howard Sherman is executive director of ESG research at MSCI ESG

This article appeared in the fall 2015 print issue of IR Magazine