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 131 money managers that responded to this question out of 365 included in this report, the most commonly reported strategy in terms of both the assets involved and number of money managers employing it was ESG integration, at $2.6 trillion and 75 percent respectively. The second most commonly reported strategy was negative or exclusionary screening, reported by 66 percent of this group of money managers and affecting $2.1 trillion of their assets under management. 

Within a subset of 86 asset owners out of 496 captured in the report, ESG integration, practiced by 60 percent of the respondents, affects the largest portion of assets under management—at $537 billion. At least 70 percent of these institutional investors use either impact investing and/or negative screening. However, the assets these respondents reported under impact investing strategies are low: just $4 billion, compared with $441 billion for negative/exclusionary screening.