UN PRI publishes reports on integration of ESG factors into equity valuation

Last week the UN Principles for Responsible Investment (UN PRI) released two reports, investigating how investors are integrating environmental, social and governance (ESG) information into their operations.

The first report  is called “Integrated Analysis”. It utilizes almost 20 case studies from brokers and research providers, including Citi, Société Générale, UBS and West LB to show different aspect of how understanding the impact of ESG factors on sales, costs and long-term return on capital can enhance investment decisions.

Screen shot 2013-02-19 at 12.18.20 PMThe structure of the review followed what the reports calls a “stylised stock review.”  It used five stages from the analysis of the economies in which a company operates, through the industries in which it operates, the way it conducts its operations, the financial impacts of those operations and finally the valuation tools used.  The document then goes on to highlight innovative research in each of these five stages.

Overall, the report finds,

advanced use of integrated analysis in all aspects of fundamental equity valuation, particularly in industry analysis, forecasting earnings and adjusting discount rates. These integrated approaches to estimating fair value point towards significantly improved valuation models that account for scarcity of resources, future regulatory directions and timeframe tensions.

However, challenges remain. The main challenges the report identifies are:

  • Short-term valuation tools cannot always capture ESG issues that will impact companies over longer timeframes;
  • Acquiring consistent, comparable, audited information remains an obstacle to integrated analysis, making it more resource intensive than traditional analysis relying on audited financial information;
  • Since there are different regulatory regimes around the world in terms of disclosure requirements ,raw ESG data without context can be misleading.

Screen shot 2013-02-19 at 12.34.11 PMThe second report, “Aligning Expectations” is intended to serve as guidance for asset owners on incorporating ESG factors into manager selection, appointment and monitoring. The report shows that asset owners featured in the report are becoming more advanced in ensuring that their asset managers meet ESG guidelines. It also shows that investment managers are rising to the challenge of integrating ESG factors into their investment decision-making.

The report also offers guidance on a number of issues in order to enable asset owners to include ESG expectations in their processes. Examples in the report include requests for proposals, questionnaires, and monitoring and discussions with managers.