The growing role of ESG integration in 2018

A major think tank highlights numerous ways in which ESG would factor into investment decisions

The growing role of ESG integration in 2018
The due diligence process isn’t getting any easier for investors. Aside from studying microeconomic, macroeconomic, and financial fundamentals, non-traditional information is being evaluated to determine portfolio risks. That includes social media, big data … and environmental, social, and governance (ESG) factors.

In a new report, MSCI has highlighted several ways ESG will be integrated into investors’ decisions. First, ESG signals will be useful to find outperformers in developing countries. MSCI noted that while emerging-market countries have poor ESG ratings, “more than 15% of Emerging Markets domiciled constituents of the MSCI ACWI Index have ESG ratings that eclipse” their own country’s ratings.

Next, they predicted an increased role for climate-change scenario testing. The institute compared the financial impact different regions of the world would sustain under a low-global-warming scenario (if global temperatures were to rise 2.5 degrees Celsius by 2100) and a high-warming scenario (rising 6 degrees Celsius by 2100). It found that Middle Eastern and North African countries would have the highest net costs under a low-warming scenario, while countries in Western Europe and South Asia would suffer most in a high-warming scenario.

“[T]he current weight of the typical investment-grade bond portfolios to regions such Middle
East & North Africa … potentially makes allocations to the global fixed income portfolio one that increases total portfolio exposure to transition risks,” the institute said.

MSCI also predicted that investors will look beyond companies’ sustainability disclosures in determining their ESG risks. While corporations are slowly caving to investors’ demands for transparency in reporting their ESG risks, the institute noted, many corporate reports are still voluntary and not subject to regulatory oversight — making them prone to brand-polishing and other forms of bias.

“We find that additional information sources are crucial to balance self-disclosed information,” MSCI said. “In the era of big data, [there’s] a wider variety of publicly available sources that can provide a more accurate and complete picture of companies’ ESG risks and performance.”

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