9.1. Enhancing the Investment Process through ESG Integration

Philip Ammann, CFA Global Thematic Equities Analyst, Vontobel Asset Management

Vontobel mtx has been applying a proprietary framework for ESG assessments since 2010 within one of their asset management teams. This framework is integrated into the investment process for developed and emerging markets with the aim of improving the risk/return profile of investments. The ESG integration approach is characterised by these key points: • ESG is a fundamental part of the investment process undertaken by the financial analysts: The investment process is based on four pillars: above-average return on invested capital (ROIC), strong industry positioning, intrinsic value, and effectively addressing ESG issues. Companies have to fulfil all of the requirements defined within these four pillars in order to qualify for investment. • ESG analysis is fully integrated into company evaluations: The same team of analysts undertakes both ESG and financial evaluations. This enables the analysts to reach decisions based on a holistic understanding of each company. Furthermore, they can adjust their financial models according to risks identified in their ESG evaluations. • Development of proprietary Minimum Standard Frameworks: These sector-specific Minimum Standard Frameworks (MSF) highlight and weigh a broad range of company-specific ESG aspects in a comprehensive ESG evaluation. The financial analysts synthesise their own analysis with the qualitative input from external providers. In addition, they evaluate forward-looking trends, such as ESG initiatives that companies have in the pipeline. • Independent ESG audit validates analysis: When selecting an ESG integration approach, an independent audit is key. An ESG professional, not otherwise involved in the investment process, ensures that the MSF scores are a true reflection of a company’s ESG performance. The ESG professional’s assessment is not influenced by an otherwise potentially strong investment case.

After several years of following this integration approach, the team wanted to gain a better understanding of the added value of the proprietary ESG assessment methodology. A test was performed to compare companies across all sectors that qualify for investment from both an ROIC and industry positioning perspective but that had differing ESG performances as indicated by their global MSF score. Analysts calculated the stock-price development of a basket of top-quartile MSF companies (equal-weighted) versus the performance of a basket with bottom-quartile MSF companies for the period between December 2012 (launch of the global product) and December 2016 (see Figure 6). The results show that companies with high MSF scores (i.e., strong ESG performance) would have outperformed companies with low MSF scores (i.e., weak ESG performance). This theoretical outperformance indicates that the defined Minimum Standard Frameworks provide important additional information about a company and are a significant valueadding factor to the investment process.

The review shows that the structured integration of ESG factors into an investment process can be an effective tool to identify attractive investments and create long-term value for investors.

Figure 6.

90 80 70 60 50 40 30 20 10 0 2012

Testing of Proprietary ESG Integration Approach (global, all sectors)*

Top-Quartile ESG Scores

2013 Bottom-Quartile ESG Scores

2014 2015 2016

*The ESG scores are based on the Vontobel mtx proprietary MSFs. The companies fulfil ROIC and industry positioning requirement (total sample size: 230). Source: Vontobel mtx (2017).