Since 2017, investors have paid more attention to environmental and social risks, and the global asset allocation is undergoing a structural change towards sustainability or ESG. The investment has shifted from the unilateral pursuit of EPS to the two-way consideration of eps-esg, and the "ESG performance" has also been added to the performance evaluation. Since the beginning of 2022, European and American countries have imposed sanctions on Russia and gpfg has had an impact on the capital market due to events such as the elimination of Xinjiang cotton and Li Ning. ESG's Enlightenment on the downside risk of investment has attracted more and more attention.
This paper explores the logic and driving force behind the ESG trend from multiple dimensions such as investment risk management. We studied the ESG inclusion framework of overseas institutions, discussed the formulation of ESG policies at the institutional level and the ESG inclusion in the investment process, which can be summarized in three points:
First, the inclusion of ESG is in line with the long-term objectives of pension and asset management institutions, so it is jointly promoted by them. From the perspective of investment value chain transmission, the consideration of ESG comes from the asset owners represented by overseas public pensions, which are subsequently transmitted to the asset management institutions and then to the invested target companies.
From the perspective of pension investment, it is highly consistent with ESG. On the one hand, the sustainable concept of ESG coincides with the long-term investment concept of pension. On the other hand, the social responsibility attribute of pension also drives its integration with ESG. The inclusion of ESG helps to improve the risk return status of pensions, help them achieve long-term investment objectives and fulfill their fiduciary responsibilities.
From the perspective of asset management institutions, on the one hand, in order to deal with the assessment of pension and other funding parties, on the other hand, for the purpose of their own investment risk management, ESG helps institutions form a more comprehensive understanding of downside risks, help them effectively manage regulatory risks, and promote asset management institutions to include ESG factors in the company's policies.
Second, governance factors are the most concerned ESG factors. For listed companies, corporate governance involves not only the company's organizational structure (board of directors, executive compensation, shareholder rights, letter phi, etc.), but also the impact of the company's business strategy and its implementation on environmental and social factors.
The purpose of corporate governance is to maximize the interests of stakeholders. From the perspective of value creation, a strong governance framework can safeguard the rights and interests of minority shareholders, which has an important impact on the valuation of the company. The world bank pointed out that a study of 539 large enterprises in 27 economies showed that enterprises in economies with good investor protection generally had higher valuations; In addition, the risk tolerance and growth rate of enterprises are positively correlated with the quality of investor protection system. A better governance system enables companies to make higher risk and more valuable investments.
Third, the ESG framework system includes the incorporation of policies and investment research processes at the company level.
The "infrastructure construction" of ESG at the company level follows the laws, regulations and regulatory guidelines of the headquarters, and refers to international norms and guidelines. Among them, the United Nations sustainable development goals and the Paris Agreement are the guidelines of ESG policies of most institutions. International norms and guidelines provide the framework, standards and principles for ESG integration and play an important role in bringing consistency and clarity to the market.
As a supplement to the traditional fundamental analysis, ESG factors can run through the investment research process and be included in the risk management at the portfolio level. Subsequently, the performance of the subject ESG can be continuously improved through due diligence management. More and more investors incorporate the general trends of reputation risk assessment, regulatory development and population aging into the basic investment analysis. In addition, ESG analysis has also been incorporated into traditional analysis frameworks such as Porter's five elements, so as to make temporary or permanent adjustments to financial index prediction, modeling assumptions, valuation multiples and financial ratio prediction.
The most commonly used ESG inclusion strategies include negative screening and ESG rating:
Negative screening is based on traditional moral values, standards and norms. Avoiding the company or country can help avoid the negative impact of supervision and accidents on the company's performance. The exclusion policies of overseas institutions have certain political tendencies. Although the norms and guidelines referred to are mostly voluntary, some pension exclusion policies are formulated under the guidance of the government.
ESG rating includes three levels of indicators to score the company's ESG performance. The low score reflects the large ESG risk exposure. In the process of making investment decisions, when other conditions are similar, the subject with high ESG score is usually given priority. However, due to different data availability and scoring calculation methods, ESG rating lacks unified standards.
In conclusion, the inclusion of ESG is consistent with the long-term objectives of pension and asset management institutions. Incorporating ESG performance into the evaluation can form a more comprehensive understanding of downside risks. In 2022, with the rise of geopolitical risks and the waving of sanctions, the resilience of ESG strategy has attracted more and more attention. In the future, it may attract more institutions to join the trend of ESG system construction.
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