By AMP Capital
The key motivation for considering ESG issues within an investment process is to gain deeper insight into areas of risk and opportunity that could materially impact the value or performance of an investment. It is a major task to identify the relevant industry-level drivers and then assess how each company manages those drivers. In order to gain new insights, and a competitive advantage, analysts must look beyond the information routinely reported by companies.
What to consider
The bulk of a company’s value is typically, and increasingly, driven by a range of intangible factors. These drivers can generally be split into two categories: sustainability drivers that relate to the entire industry (such as the relevant demographic, regulatory and technological change) and intangible drivers that focus on each company’s response.
While the specific sustainability drivers and their relative importance will tend to vary from industry to industry, there is a clear correlation between how effectively a company manages them and financial returns.
Before embarking on ESG analysis, it makes sense to take a step back and consider the factors driving earnings growth at the industry level. When determining which intangible drivers are most relevant to a particular industry, an ESG analyst would consider:
- Environmental factors: How likely is it that the value of a company in this sector will be influenced by how well they perform as a steward of the natural environment?
- Social criteria: How likely is it that the value of a company in this sector will be impacted by how a company manages relationships with its employees, suppliers, customers and the communities where it operates?
- Governance: How likely is it that the value of a company in this sector will be impacted by the quality of its leaders, the fairness of its pay structures, the audits and internal controls, and finally the rights of shareholders?
Why ESG matters
Over the long-term, factors such as a company’s governance, leadership and their attitude towards risk are likely to have a greater influence on company value and share-price performance than the tangible factors that are traditionally considered by investment analysts.
It’s important to compare the ESG attributes of individual companies and consider how these factors impact relative value and the long-term sustainability of company earnings.
Research focuses on a broad range of factors:
- Demographic trends
- Climate change
- Technological advances
- Risk management
- Supply-chain management
- Employee engagement
- Company culture
- Board diversity
- Occupational health and safety performance
Unsurprisingly, when company earnings rely on them taking short-cuts and exploiting under-priced pollution, under-paid labour or weak regulation, the current level of their earnings may not be sustainable.
A deep dive into how a company is managing its ESG risks and opportunities can deliver investment insights that lead to better informed investment decisions and potentially higher returns.
For more information on ESG issues, please see our latest corporate governance report
While every care has been taken in the preparation of this document, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) make no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.