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Reasons To Use ESG Integration

The rapid growth of macroeconomic trends, like technological advancements, climate change and shifting socio-demographics are bringing us closer to an era that will be quite different from the present. As the global economy and the social landscape evolve, these changes can create new risks and present new opportunities for investors in the coming years.

The evidence is growing to demonstrate that companies that address non-financial environmental and social governance (ESG) risk factors like work circumstances (including the modern-day slavery) and climate change and who concentrate on good governance will also be more profitable over the long run.

One of the most comprehensive researches in this field, Deutsche Bank and the University of Hamburg examined more than 2,000 research studies related to ESG integration and financial performance. They discovered it was true that ESG Integration did not negatively affect the return on investment in the majority of studied studies. And generally it was beneficial.

In the same way, MSCI ESG data demonstrates that businesses that have greater ESG ratings typically have gross margins of profit that exceed the overall market (see the chart above). A study conducted by MSCI goes further and found that businesses that were rated higher in ESG generally had greater financial performance for their businesses (controlling other aspects including size, quality, and).

Additionally, the gap in return between the top and bottom ESG-rated firms appears to have been growing in recent times, with it being at or near 2.9 percent in the last five years (2015 through 2019).

In turn, the demand from pension schemes for investments in companies that have robust ESG profiles is growing rapidly. For this reason trustees and consultants as well as asset managers need to gain a better knowledge of the ESG elements that will most likely affect the financial performance of a particular investment.

ESG integration is a way to do this. It is defined as part of the Principles for Responsible Investment (PRI) as “the explicit and systematic integration of ESG concerns in the analysis of investment and decision-making about investments” It assists investors in identifying and managing ESG risks, in conjunction with other financial information to measure the goals strategy, the quality of management, and the strategy of businesses. This all will affect the company’s performance and will be related to equity returns.

The advantages of ESG integration can be described as follows:

* Improving the performance of corporates

The long-term financial benefits that comes from ESG Integration at the corporate level is that more effective ESG practices will improve the company’s financial performance as well as financial value.

* Strengthening long-term future investment returns

ESG data and metrics can help improve portfolio construction and decision-making about stocks. This could help to create more long-term value, and reduce ESG risk.

* Progression in ESG integration improves valuations as well as return on investment

The investment in companies with greater momentum ESG ratings are likely to experience greater improvement on their performance in the financials. This leads to higher valuations and better return on investment.

* Stronger resilience to extreme risk events and less return volatility

The real-world examples illustrate that not taking care of the financial risk posed by ESG issues can seriously impact the performance of a business and negatively affect the value of shareholders.

This means that ESG aspects are likely to play a more significant and consistent function in the formulation of strategies for allocation of assets, portfolio construction and selection of managers. It will also be essential to support strategies’ long-term perspectives and complementing conventional financial analyses as a part of the investment decision-making process.