ESG stands for Environmental, Social and Governance factors. ESG integration is the practice of considering material ESG factors as part of the investment decision-making process to identify and assess potential risks and opportunities that can impact long-term, risk-adjusted returns.
ESG integration falls under the umbrella term, Responsible investment.
- Responsible investment includes a broad range of approaches that can be used to incorporate ESG considerations into the investment process.
- ESG integration, ESG screening & exclusion and thematic investing are different approaches to Responsible Investment, but are not mutually exclusive.
- ESG integration can help to identify potential risks and opportunities in addition to traditional financial analysis.
When you integrate ESG factors into your decision-making process, you can gain a deeper understanding of companies before you invest as well as after you are invested. This includes insight into how the company may perform and the value it may add to a portfolio. Research indicates that companies with strong ESG-related practices have produced:
- lower risks
- lower cost of capital
- better operational performance
- better share price performance over the longer term1.
Watch this video featuring our investment team on “Why ESG is important”.
Watch time: 3 minutes 56 seconds
In this video, our experts share their views on:
- Why analyzing ESG factors is an important part of the investment process
- How RBC GAM approaches an active ownership and engagement.
ESG factors may not always fit into one specific category. Climate change is a good example. We usually think of it as an environmental issue, but it has far-reaching implications that include social and governance risks. Changing weather patterns can disrupt supply chains, while company boards can support or oppose requests from shareholders for transparent climate-related disclosures.
Examples of ESG factors:
|climate change||employee health and safety||executive pay|
|greenhouse gas (GHG) emissions||supply chain risk||bribery and corruption|
|biodiversity||cybersecurity and data privacy||board diversity and structure|
Traditionally, a portfolio manager chooses to invest in companies based largely on their financial metrics and reports. They might look at things like earnings, profit margins and debt levels. But in recent years, there has been a growing focus on looking beyond the balance sheet. When you integrate material ESG factors into the investment decision-making process, you can assess many other kinds of risks a company faces. For example, portfolio managers or investors may ask:
|Environmental: How does a company’s business impact the environment?||Social: How does the company interact with its employees, customers and communities?||Governance: How does the company govern itself? Is it free from bribery and corruption?|
An ESG risk refers to a risk a company may face due to weak ESG practices. Here are some examples of strong versus weak ESG practices:
|Company Focus||Strong ESG||Weak ESG|
|Employees||Engagement, strong culture, innovation||Lack of training, unsafe conditions, high turnover rate|
|Customers||Responsiveness, availability, dispute resolution||No returns policy, poor labelling, over-charging|
|Suppliers||Timely payment, good production planning||Lack of audit, lack of quality control|
|Environment||Strong climate strategy, sustainable sourcing, renewable energy||Pollution, lack of climate strategy|
An ESG fund typically refers to a fund that focusses on ESG factors as part of its investment objective. It may also refer to a fund that integrates ESG as part of its investment strategy.
ESG screening & exclusion looks to apply positive and/or negative screens to include/exclude securities from a portfolio while thematic ESG investing focuses on issuers with involvement in a particular ESG-related theme, such as gender diversity or environmental and social solutions.
ESG integration, on the other hand, is not about excluding securities, but rather, involves assessing material EGS factors as part of investment decision-making. This means that a fund that integrates ESG factors may hold companies with high ESG risks or poor ESG practices, with the goal of having the company improve in these areas, resulting in better financial performance. In these cases, the asset manager may engage with the company to encourage stronger oversight and management of ESG risks.
It’s important to note that these approaches are not mutually exclusive –an investment may exclude certain securities and integrate ESG factors into the investment process.
Responsible Investment (RI) continues to grow in importance for investors, advisors and communities. In fact, more than US$35.3 trillion was invested in RI around the world at the start of 2020. That’s a 15 per cent increase in two years. In Canada, RI rose 48 percent between 2018 and 2020. Canada is now the market with the highest proportion of sustainable investment assets.2
Our solutions cover a broad range of responsible investment approaches including ESG integration, positive and negative screening, and thematic investing. Learn more about our responsible investment solutions.
Talk to your advisor about how you can include RI solutions into your investment portfolio.
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