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Portfolio > Portfolio Construction > ESG

Alpha Could Be Hiding in ESG Data: Report

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Integration of environmental, social and governance data into investment analysis can uncover risks and opportunities that markets have yet to value, according to a new report.

The report by Calvert Investment Management, a firm focused on socially responsible and ESG investing, and George Serafeim, the Jakurski Family Associate Professor of Business Administration at Harvard Business School, looks at how systematic analysis of material ESG information may boost portfolio returns without adding additional risk.

Such an analysis is important in the current market environment where it’s increasingly difficult to generate alpha based purely on analysis of financial metrics.

“As the correlation between companies’ sustainability initiatives and their financial performance crystallizes, investors need to be factoring material ESG data into their investment evaluation and decision-making process,” Calvert Investments chief executive John Streur said in a statement.

Streur said the report reinforces decision-making by asset managers and owners who seek to allocate capital in a way that rewards good corporate behaviors identified through integrated ESG analysis.

According to the paper, the improved quality, consistency and availability of corporate financial data have lessened opportunities to generate alpha.

In contrast, broad access to insightful ESG data remains cloudy. Companies’ nonfinancial disclosures are noisy, inconsistent and selective.

But this very opacity presents opportunities for investors who analyze both financial and ESG data sets.

The report says that incorporating material ESG data into investment analysis can provide investors an advantage, as the data can be a leading indicator of future financial performance. It can give insights into the quality of a company’s business model and management not available in financial data alone.

The authors note that this particular advantage holds only under analysis of financial materiality. It is not empirically supported by incorporation of broader, nonfinancially material ESG data.

According to the Calvert-Serafeim paper, investors who focus on material ESG factors may have a leg up in selecting stocks that are likelier to improve profit margins over time, as companies that invest in material ESG areas have the potential to outperform in terms of risk-adjusted stock price and profitability margin growth.

Moreover, besides yielding financial returns for investors, companies that integrate ESG information in investment decisions can also promote social and environmental outcomes, particularly through the direct effect on their cost of capital.

As well, these companies will experience opportunities to expand, thus multiplying both their ESG practices and their environmental and social impacts.

In contrast, companies that have poorer ESG performance will tend to contract.

— Check out ESG Analysis ‘More Dynamic,’ but Ambivalence Remains on ThinkAdvisor.


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