ESG Incorporation

A key strategy of sustainable and responsible investing is incorporating environmental, social and corporate governance (ESG) criteria into investment analysis and portfolio construction across a range of asset classes. An important segment of ESG incorporation, community investing, seeks explicitly to finance projects or institutions that will serve poor and underserved communities in the United States and overseas.
In ESG incorporation, investment institutions complement traditional, quantitative techniques of analyzing financial risk and return with qualitative and quantitative analyses of ESG policies, performance, practices and impacts. 
Asset managers and asset owners can incorporate ESG issues into the investment process in a variety of ways. Some may actively seek to include companies that have stronger ESG policies and practices in their portfolios, or to exclude or avoid companies with poor ESG track records. Others may incorporate ESG factors to benchmark corporations to peers or to identify “best-in-class” investment opportunities based on ESG issues. Still other responsible investors integrate ESG factors into the investment process as part of a wider evaluation of risk and return.
These examples of ESG incorporation strategies can be summarized as follows:

  • Positive/best-in-class screening: Investment in sectors, companies or projects selected for positive ESG performance relative to industry peers. This also includes avoiding companies that do not meet certain ESG performance thresholds.
  • Negative/exclusionary screening: The exclusion from a fund or plan of certain sectors or companies involved in activities deemed unacceptable or controversial.
  • ESG integration: The systematic and explicit inclusion by investment managers of ESG factors into financial analysis.
  • Impact investing: Targeted investments aimed at solving social or environmental problems.
  • Sustainability themed investing: The selection of assets specifically related to sustainability in single- or multi-themed funds.

The survey of money managers and asset owners conducted for the US SIF Foundation’s Report on US Sustainable, Responsible and Impact Investing Trends asked respondents to describe their approach to ESG incorporation. Of the 100 money managers that responded to this question, 62 indicated that they practice ESG integration across $1.5 trillion in assets, making it the most common strategy in asset weighted terms. This comprises just over 70 percent of the subset’s total ESG incorporation assets. If extrapolating to the larger group of 300 money managers identified in the report as practicing some form of ESG incorporation across $8.1 trillion, as much as $5.8 trillion could be engaged in ESG integration.

In a subset of 75 asset owners out of 477 captured in the report, the majority identified negative/exclusionary screening as the most common strategy across $664 billion in assets, or 86 percent of their ESG incorporation assets. If applying this percentage to the larger group of 477 asset owners, negative/exclusionary screening could affect up to $4 trillion in assets.