Glossary term
ESG Integration
Subject: Sustainability and ESG, Sustainable Finance and Responsible Investment
Also known as: ESG investment integration, Integration of ESG factors
ESG integration is the explicit inclusion of environmental, social and governance factors in an investor's analysis and decisions, alongside financial data, because they can affect risk and return.
Explanation
Integration does not exclude sectors or chase a social goal. Analysts treat factors such as carbon exposure, labour practices or board quality as inputs to forecasts, valuation and portfolio construction, in the same way they treat debt or competition. A credit analyst may widen the risk premium for a company facing flood risk, while an equity analyst may trim expected profits for a firm facing fines over safety failings. Firms usually record how the factors were weighed and who is accountable for it. Integration is one of several responsible investment approaches, next to exclusions, best-in-class selection, stewardship and impact investing. Asked to prove that a fund really does this, a manager points to the written record of how the factors changed a forecast or a position size.
Example
An asset manager reviews a mid-sized shipping company. Its analyst models the cost of coming carbon rules on fuel, notes a recent pattern of crew safety incidents, and sees that the founding family holds board control. The analyst lowers the earnings forecast and the target price, and the portfolio manager cuts the position size.
Not to be confused with
- Impact Investing
- Aims for measurable social or environmental results as well as return. ESG integration only factors ESG issues into financial analysis.