Tag Archives: ESG Due Diligence

ESG investing is one of the fastest-growing trends in the investment world. Asset Managers are moving towards ESG investing at a great pace, not only due to regulatory compliance requirements but also because ESG investing has been proven to show better returns and alpha in the past.

What is ESG investing?

ESG stands for Environmental, Social, and Governance and ESG investing relates to evaluating these parameters while analyzing a potential investment.

ESG which was a niche investing technique only a few years back is now the centerpiece of the majority of the investments being evaluated globally. ESG investing trend has seen a massive uptick. The global market for ESG touched $30.7 trillion in 2018 representing a growth of 34% over 2016. It is expected to touch $35 trillion by 2020. The global coronavirus pandemic of 2020 will give further fillip to this trend. Multiple ESG funds, that specialize in ESG based investments is a common theme now

Why is ESG investing important?

ESG specifically touches on some aspects of investments, that are proven to generate superior returns in the past. Investments that are evaluated properly on ESG metrics are more resilient to inherent business risks. ESG investment performance has been better than other investments. Even ESG ETF has shown better performance compared to peers.

ESG of course is the only sustainable way of investing to ensure that the planet we live on, is not distorted and polluted beyond repair and probably the only strategy that could guarantee a really long term performance

Here is a typical example of how ESG could play a vital role in assessing the reliability of the ESG investment in companies

Environmental Factors

Here the relevant factors are resource use, emissions, environmental opportunities, pollution, waste, green supply chain, carbon footprints, and everything else touching the environmental aspects that a given industry, or a company operates in. If a firm is on the wrong side of the environmental side, there could be an enhanced risk of running into bans and penalties, all of which poses a long-term bottom-line impact.

Social Factors

Here the factors relate to society, people, and the workforce in general. The relevant factors here would be Workforce, Social Opportunities, Data Privacy, and Product Responsibility. Social factors are the most important factor for any people-based business. If the “people” part of the business is taken care of, it’s imperative that investments would generate desirable returns in the future, because “people” forms the most important lever for the business profitability

Governance Factors

Governance includes factors like Risk Responsibility, shareholder rights, and CSR initiatives. It is the ability of the management to discharge its fiduciary responsibilities towards the investors. History is full of examples like Enron where Governance made the difference between success and failure. Governance is at the heart of trusting the financial performance and documents related to an investment.

Hence it’s evident that ESG investment for funds like Hedge Funds, Private Equity, Venture Capital Mutual Funds, and ESG Bonds may lead to superior alpha

So, ESG aspects need to be analyzed in detail before making an investment decision.

ESG across the investment value chain

ESG analysis framework for investments for asset management plays its role across the full value chain of investing. Here is how ESG aspects need to be analyzed across the investing value chain so that ESG risk is minimized

ESG across investment value chain

ESG across the investment value chain of companies

Deal Origination

ESG has to play a significant role in the deal origination stage itself. All the deals that are in the pipeline need to go through a quick and dirty assessment of ESG. Here the key is to have the relative comparison across opportunities and still not diving too deep into the evaluation. Also, care needs to be taken to identify the investments that have painted themselves as ESG investments, without following the principals in essence.

Due Diligence

At the stage of Due diligence, the quick and dirty analysis changes into a detailed one. Here the second level of data is collected. Also involved in the process are ESG specialists, data and reporting specialists, and the business experts to have a holistic view of the ESG preparedness of the investment. Also during Deal execution, while arriving at the valuation of the opportunity, the analyst needs to assign the relevant weights to the ESG related red flags and advantages. A benchmark with available ESG standards from ESG rating agencies is performed. A detailed ESG questionnaire is also prepared for the due diligence.

Portfolio Management

ESG plays out even after the investment decision. The portfolio needs to be continually monitored for ESG related red flags, violations, and the efforts made and required in the ESG direction. A centralized Project Management Office for ESG efforts of all portfolio companies goes a long way in establishing common standards across all portfolio companies. ESG policy compliance and ESG disclosure norms are also monitored and managed.

Reporting and Compliance

ESG reporting and compliance standards are still evolving. Europe particularly has taken a lead in ESG compliance over the US and APAC. It’s a matter of time that other geographies also catch up. Even Europe’s standards are not detailed to the second and the third level. This is expected to change in the future. Standards like GRI, SASB, TCFD, and several others across geographies need expert intervention for compliance.

Challenges related to ESG data collection

There are multiple challenges related to the data collection process when it comes to ESG. Here are the major challenges

ESG Data Challenges

ESG Data Challenges and Solutions

 

 

 

 

 

 

 

Data is not scalable: Due to the patchy nature of data available across the investment avenues, there are limited options for streamlining and scaling up the data operations.

Customized Data Requirements: Every Asset Manager has a different ESG mandate and there is no one size fits all approach to data collection. Every data collection exercise needs to be customized to effectively capture information that serves the investment mandate

Voluntary reporting: Though compliance standards are evolving, still most data reporting is voluntary. This presents challenges in evaluating and comparing data points across investment avenues.

Incomplete Data: Data many a time is incomplete and there is a huge dependency on proxy information to complete the picture

Incomparable formats: The available data are spread across geographies and varying reporting standards. It presents challenges in comparing the data points across multiple investment options

Lack of reliable sources: There are some sources for ESG data and ESG index but there is none that is fully reliable. Hence there is a need to depend on multiple sources to complete the picture of ESG evaluation

A solution to the Challenges

Magistral Consulting offers a full suite of data services when it comes to ESG data collection, treatment, and presentation. Magistral relies on ESG experts along with data research and visualization experts to present a holistic picture. AI and automation tools further reduce the cost of data collection. All the solutions are customized as per the needs of Asset Managers so that the solution helps the Asset Manager in achieving a superior alpha. ESG research is performed by experienced ESG analysts

The unique advantages of Magistral’s solutions are ESG operations cost reduction, and the panel of experts on ESG, SME, ESG consultants, and Investment Research

Magistral’s ESG Services Framework

Magistral follows a customizable plan to offer ESG data services.

ESG Framework

Magistral’s proprietary framework for ESG evaluations

 

 

 

 

 

 

 

Here are the major aspects of the framework:

Data Collection: The key is to access as many data sources as possible about the ESG stock. Even when the complete data is not available, opinions, insights, and experts’ views help. ESG investing criteria is crystallized

Alignment with the mandate: Although a wide array of ESG data is collected but not all data points may be relevant for the ESG investing for the Asset Manager. In this stage, data is aligned with the investment objective, investment philosophy, or the investment mandate. This is where the views of Asset Managers are built into the process. ESG investing strategies of the Asset Manager is also built-in.

Modeling: All customizable aspects are built into the model so that investment avenues could be objectively compared and evaluated. ESG ratings or ESG score are arrived at, in this stage

Reporting: Reporting could be done through customized tools like web-based distribution, excel models, or cloud sharing tools. Effective visualization for ESG metrics is incorporated to pass on the right messages.

Magistral Consulting has helped Hedge Funds, Bonds, Private Equity, Investment Banks, Mutual Funds, ETFs, and Venture Capital in analyzing ESG aspects of investments across the globe

About Magistral

Magistral Consulting has helped multiple funds and companies in outsourcing operations activities. It has service offerings for Private Equity, Venture Capital, Family OfficesInvestment BanksAsset Managers, Hedge Funds, Financial Consultants, Real Estate, REITs, RE fundsCorporates and Portfolio companies. Its functional expertise is around Deal originationDeal Execution, Due Diligence, Financial ModelingPortfolio Management and Equity Research

For setting up an appointment with a Magistral representative visit www.magistralconsulting.com/contact

About the Author

The Author, Prabhash Choudhary is the CEO of Magistral Consulting and can be reached at Prabhash.choudhary@magistralconsutling.com for any queries or business inquiries.