Raising the Concept of ESG Performance Analysis

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Sustainability & financial growth: how to achieve these two challenging goals at the same time?

Together with recent growing awareness of the need for sustainability, ESG investing (environmental, social, and governance) is reshaping the way financial institutions are thinking about their portfolios. Among other impressive numbers, McKinsey estimates than 25% of global assets totaling USD 88 trillion were actually driven by ESG standards by the end of 2017.

ESG is now commonly embraced as a key investment criteria for institutional investors. However, at the back of this powerful change, we have not yet seen a revamping of the asset management tools needed to accompany such a change, and too many institutional investors are still seeing financial and ESG performance in different silos. It is a little like electric cars having no places in town to recharge; many would like to adopt them, some buy them, but in fact, it remains challenging to use them day after day.

This lack of a proper data and calculation setup unfortunately always leads to the same debate which we see in every country and which many board members have in mind, even without being vocal about it: should we favor financial growth, or should we focus on sustainability? The good thing is that now we all know there is only one long term answer to this question, even if we struggle to implement it: both.


ESG Performance Analysis

So how can we achieve these two challenging goals at the same time? Success comes by mixing financial and non-financial metrics in a combined ESG performance analysis, which now has to become more popular not only among top institutional investors, but also with private wealth managers or asset managers.

In the way to manage and monitor a portfolio, we have seen the so-called ESG portfolio integration approach, combining, for example, low carbon and quantitative factors (which are also gaining in popularity, as Fidelity mentions net inflows of $250 billion between 2011 and 2016. In fact, these strategies had net inflows of nearly $250 billion during the past five years). If investment banks and large asset managers have developed the technique for years, it requires advanced tools which are not yet available to most financial institutions.

For example, take performance analysis, a mandatory step each portfolio manager performs on a regular basis to understand its portfolios, figure out its key drivers, and maintain winning or losing bets. While looking at standard metrics such as country, sectors, currency, and asset class, one can also incorporate ESG ratios and KPIs to the study.

Such ESG performance contribution would answer questions such as:

  • Do the companies with the highest ESG scores perform better than other?
  • Am I losing returns and opportunities because of a too tight calibration of my ESG exclusions?
  • Are companies with the highest dispersion in ESG scores performing like their other peers?
  • Can I build a set of ESG and financial ratio clusters to build a balanced and optimized portfolio?

More and More Complex Portfolios, More and More Complex ESG Ratings

While pure long-only Equity portfolios are relatively simple to study from an ISR point of view, institutional investors, most of the time, have complex, multi-asset portfolios which cannot be properly analyzed by standard reports. In particular, derivatives, short positions, hedge funds or large positions in infrastructure deals require a lot of attention when it comes to assessing their ESG impact. We can also mention that, more and more, ESG analysis goes back to the entire chain of valor for a given company and aims at figuring out the total impact it has on climate change and human rights.

Take a solar energy company, for example. If its purpose is great (perhaps aiming to help reduce global warning), some have their activity in regions where employment rights are very low. Looking at the full value chain, the ESG scores have to get more diverse and complete, and their assessment at the portfolio level makes it need to be properly done. Entering into more details, the relationship between ESG and the search for traditional financial profit looks even more obvious, and even more so when one considers impact investing.

First, one should clarify the difference between the two terms, which we could define as such:

  •  ESG is, in the first place, a risk management tool. Should climate change too much, for example, this will have disastrous consequences on everything, including on the economy, and as such, it is bad for a portfolio. It is a long-term risk compared to some other metrics, but it is such a big one which one has to take into account.
  • Impact investing stands for companies or initiatives which will have a positive and concrete impact on the populations or on the environment. It does not address a risk as ESG goes, but rather, impact investing addesses a cause.

Take the UN sustainable development goals, for example, the well-known list of 17 objectives to be pursued in an effort to protect the planet. It covers topics such as industry innovation and infrastructure, quality education, good health and well-being, or securing clean water and sanitation. These domains are definitely driven by both financial constraints and generous objectives, and they should be treated as such in portfolio management tools.


Quantilia ESG Portfolio Analytics brings ESG into the core portfolio management tool

Quantilia is now gathering thousands of securities, funds, stocks, and ETFs and running in-depth ESG analysis thanks to specialized partners. All our tools and analytics allow institutional investors to embrace ESG investing as a source of performance and not as a constraint, and it enables institutions to create tailored reports suited to their ESG ambition.

From performance contribution to Brinson-Fachler performance attribution methodology, Quantilia helps investors by assessing the efficiency of a portfolio versus a benchmark with ESG as a common filed of interest.

Quantilia ESG Portfolio Analytics aims at bringing ESG into the core portfolio management tool to fill in that gap and allow institutional investors to look at their performance analyses also from an ESG point of view, providing a more well-rounded point of view.