What is ESG integration & why is it important?

ESG (Environmental, Social, Governance) is expected to continue growing in 2022 after a watershed year that saw a record $649 billion poured into ESG-focused funds worldwide. In 2021, 61% of Morningstar’s ESG-screened indexes outperformed their broad market counterparts globally and across all markets, so it's no surprise that potential shareholders are looking for ESG-friendly investments and businesses are trying to capitalize on the increased popularity of sustainability.

As a result, investors, asset managers, and businesses are all seeking ways to prioritize and integrate ESG into their investment decisions and corporate strategies. While there’s no one-size-fits-all approach to ESG integration, here are some ideas on how investors and companies alike can get started.

What is ESG integration?

While some individuals (wrongly) believe that ESG is solely concerned with environmental sustainability, yet it encompasses much more. ESG refers to traditionally non-reported factors that don’t appear on the balance sheet but are important for corporate values such as brand value and reputation. ESG integration can support the analysis of corporate decisions that affect operational efficiency and future direction as well as increased risk-adjusted returns and long-term viability.

ESG integration also aids in the assessment of risks and opportunities in businesses and portfolios. For example, exposure to extreme weather, water scarcity, and carbon emissions can all pose of environmental risks. Clean technology, green building, and renewable energy are examples of environmental opportunities.

Ultimately, all of these risks and opportunities provide information about the company, such as its environmental footprint and green initiatives, how much it contributes to the community, and how well it will withstand relevant laws and regulations, as well as any legal controversies.

While the ESG considerations that are material will vary by investment style, sector, industry, market trends, and client objectives, ESG integration uses research, data, and insights to better inform investment and management decisions.

Why ESG integration is good for business

The benefits of addressing ESG issues extend beyond satisfying institutional shareholders and building a positive public image. For example, a successful ESG program can help companies gain access to vast pools of capital, strengthen their company identity, and encourage long-term growth. Other benefits of ESG integration include:

• An increase in stock liquidity: Individual and institutional investors are putting large sums of money into companies with strong ESG programs that are proactive in governing and operating in an ethical and sustainable manner. Global investments utilizing sustainable, responsible, and impact investing techniques surpassed $17 trillion in 2020, according to the US SIF Foundation Biennial Trends Report.
• An increase in value: ESG activities may help businesses generate competitive value by making it easier for them to adapt to changing socio-economic and environmental conditions, as well as discover strategic opportunities and overcome competitive obstacles.
• Committed shareholders: Because ESG investors are values-based investors who care more about what happens in the next decade than in the next quarter, they are more likely to stay invested. Investors who incorporate ESG into their mandate frequently collaborate with companies to improve them, as they are more concerned with developing long-term value over time rather simply flipping stocks in the short term.
• The ability to retain talent: Companies that promote strong ESG values have been found to be successful at attracting and retaining employees who are loyal, passionate, and feel valued. This commitment can help generate intangible goodwill, which reinforces the company's brand and boosts employee productivity.
• Stronger analysis: Integrating ESG aspects into investment research and decision-making processes results in more informed investment plans and better management. ESG data also serves as an early warning system for risks that aren't yet reflected in asset values, allowing for more thorough analyses and valuations.

How to better integrate ESG

The ESG landscape is complex and ever evolving as priorities, legislation, and regulations constantly shift and change. If you want your ESG program to deliver value, it’s vital to ensure that ESG strategies are embedded into all corporate strategies.

Companies can:

• Identify ESG risks throughout the supply chain
• Implement policies to improve diversity and inclusion
• Incorporate ESG goals into executive compensation decisions
• Ensure strategic objectives include ESG considerations
• Educate your workforce on the need to embed ESG across all operations

Investors can:

• Define your investment belief, which will guide your sustainable investment strategy and help embed it throughout the organization
• Create an integrated framework to assess ESG risks and opportunities
• Gain access to leading research and reliable ESG data
• Use qualitative analysis to assess the economic factors, industry benchmarks, and quality of company strategy and management
• Employ quantitative analysis for financial forecasting and models of company valuation, quant, and portfolio construction
• Make sure you take active ownership of assets through company engagement and voting rights

It’s also critical to identify ESG criteria and understand the three key components to ESG investing: the environmental, social, and governance aspects.

Environmental issues can include factors such as carbon emissions, climate change vulnerability, water sourcing, biodiversity and land use, toxic emissions and waste, packaging material and waste, and electronic waste.

Social issues include factors such as labor management, worker safety training, supply chain labor standards, product safety and quality, and consumer financial protection.

Governance issues can include the composition of the board in terms of diversity and independence, executive compensation, accounting practices, business ethics, and tax transparency.

For investment firms implementing ESG, it’s important to set ESG criteria priorities. For example, Trillium Asset Management uses a selection of ESG factors to help identify companies they want to avoid as well as companies to add to their portfolio.

Trillium's ESG criteria includes avoiding companies that operate in higher-risk areas or have exposure to coal or hard rock mining, nuclear or coal power, private prisons, agricultural biotechnology, tobacco, tar sands, or weapons and firearms as well as companies that have major or recent controversies with human rights, animal welfare, environmental concerns, governance issues, or product safety.

Some positive ESG criteria, on the other hand, includes companies that put out carbon or sustainability reports, limit harmful pollutants and chemicals use, renewable energy sources, operate an ethical supply chain, support LGBTQ rights and encourage diversity, pay fair wages, and embraces corporate transparency.

The power of ESG data & reporting

Whether you’re a company or investor, ESG data and reporting will lay the groundwork for successful outcomes. ESG data gives investors crucial information about a company's performance and allows firms to create and track ESG goals. While ESG data can be difficult to obtain and combine for many firms, it is critical in providing investors and other stakeholders with transparent and measurable information.

ESG reporting is essential for building a robust portfolio that attracts investment. Organizations can use ESG reporting to better understand and manage their impact on people and the environment, as well as identify and mitigate risks, seize new opportunities, and take actions that build brand value and trust.

ESG materiality assessments

With investors inquiring more and more frequently about what your company is doing in regard to responsible investment, how you treat employees and vendors, your dedication to sustainability initiatives, and other activities that fall under the ESG umbrella, it’s important to have answers to these questions.

An ESG materiality assessment empowers you to easily report on your current state and outline future initiatives while taking into consideration your business goals and risks. Download our guide to creating and extracting the maximum strategic value from an ESG materiality assessment.

Download guide

Michelle Winters

Michelle Winters is our VP of Sales. Previous to this role she oversaw the account management & consulting teams. Michelle's roles have allowed her to successfully ensure that our clients see increased value, optimization of their strategies, and the right solutions to position them for growth and success.

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