24 Oct 2019
24 Oct 2019
With the inexorable rise in demand for ESG investments, Lyxor ETF is bringing the latest thought leadership straight to investors. In this guest blog,Zoltán Nagy, Executive Director, Equity Core Research at MSCI,explains what kind of things MSCI looks out for when rating companies for sustainability.
Greater climate change awareness is supporting a strongly increasing trend in environmental, social and governance (ESG) investing. Investors have become much less tolerant of corporate ESG incidents and more willing to act because of them, creating a kind of virtuous circle. When investors take more notice of ESG events, those events may have a greater impact on financial performance, and this encourages more investors to take them seriously, starting the cycle again.
30 years ago, Exxon’s stock price barely moved when Exxon Valdez spilled 11mm gallons of oil on the Alaskan shore. It is hard to imagine that happening today, with social media allowing for immediate, global communication of issues. Investors are making companies accountable for their actions.
Supporting this shift is the vastly growing ESG data set, generated by a wide array of sources. Social media and self-disclosure policies, as well as work by NGOs and governmental organisations scrutinising company behaviour, creates large amounts of data that, when understood, can better inform the investment process. At MSCI, we have made significant investments in our ESG ratings capability to help institutions understand this data to make better investment decisions.
MSCI ESG ratings
MSCI ESG Ratings are designed to help investors understand ESG risks and opportunities and integrate these factors into their portfolio construction and management process. This is not just about environmental, social, and governmental risks, but how those factors relate to a company’s financial performance.
Our ESG research involves taking a huge data set and extracting the relevant information – then distilling the results into company, industry, and thematic reports, which can run to dozens of pages.
One aspect of our research is corporate controversies, which are a major component of ESG risk. MSCI ESG Controversies allow institutional investors to analyse a company’s impact by identifying involvement in major ESG controversies, adherence to international norms and principles, and assessing company performance with respect to these norms and principles. We categorise five major kinds of controversy: environmental, human rights and community impact, governance issues, customers, labour rights and supply chain. Our first priority is to assess the severity of a controversy: for example, would it cause death, or something less serious such as inflammation? Then we assess breadth: would this controversy affect a handful of people or millions?
Our analysis results in a final score between 0-10, usually represented in a traffic light system. This controversy score can be combined with our ESG score methodology. For the ESG score, first we evaluate all companies with regards to governance structures – how the board is structured, the executive pay, and so on – then select the most relevant environmental and social ESG risk factors relating to that company’s industry. For example, looking at soft-drinks company Coca-Cola, the key risks are: product carbon footprint, water stress, packaging material and waste, health and safety, and finally opportunities in nutrition and health.
Different ESG issues are significant for different industries. The financial industry suffers from far more bribery and ethical controversy than the utilities industry, for example, while the utilities industry is far more exposed to carbon emissions issues.
Finally, we combine the business activity data with geographic data to analyse risk exposure. What matters to us is risk exposure – not just disclosure – and how well a company is equipped to handle the risks we have identified. From this we create a “Leaders and Laggards” ranking, which is a peer-relative rating within industries, meaning in each industry you have AAAs, down to CCCs.
There are three key transmission channels from ESG to financial value, according to our research: over a ten-year period, a higher ESG profile was associated with 1) profitability; 2) tail risk; and 3) systematic risk.
What is the framework for investors to access ESG in 2019? Historically the method was to align a portfolio with an investor’s ethical or political values, but the industry is now moving away from value-based screening (for example, an index that excludes fossil fuel) as a guideline. Nowadays, there is a growing focus on ‘targeted impact’ – meaning how to generate a measurable social or environmental impact, such as improving the environment or encouraging greater gender diversity.
MSCI’s ESG index family offers options for institutional investors with any ESG preference, whether they are looking to integrate ESG risks, meaning incorporating certain factors to enhance return; to invest with a values-based approach; or to target a specific impact.
Our “Select ESG Rating and Trend Leaders” indices are uniquely designed to target companies that have a robust ESG proﬁle as well as a positive trend in improving that proﬁle.
Zoltán Nagy, Executive Director, Equity Core Research at MSCI
The view from Lyxor
Rather than striving to achieve a specific impact, Lyxor’s ESG Leaders ETFs could appeal to those investors simply trying to “do something” with their money by making a broader, positive contribution to society. We partnered with MSCI, a leading expert in ESG data and scoring, to help identify those companies possessing a robust ESG profile. While our Europe ESG Leaders fund targets the ESG champions of today, our Trend Leaders funds go one step further by also rewarding companies who have successfully improved their ESG rating over the previous year.
This article is for informative purposes only and should not be taken as investment advice. Lyxor ETF does not in any way endorse or promote the companies mentioned in this article. The opinions expressed by Zoltán Nagy are his own, as at September 2019, and do not necessarily reflect the views of Lyxor International Asset Management or Societe Generale. Capital at risk. Please read our Risk Warning below.
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