A walk through our proprietary ESG research process
At Quantum Advisors, Environmental, Social and Governance (ESG) considerations are being increasingly embedded in the investment process. We believe that companies which focus on ESG issues tend to have a lower risk profile and are better prepared to deal with possible negative externalities. Companies adopting a sustainable framework to their operations are perceived to have more credibility and the framework can be used as a source of competitive advantage that allows them to deliver superior returns over the long term.
ESG Scoring methodology
We use our proprietary methodology to evaluate the ESG performance of the company on two broad parameters.
1) Disclosures (30% weight): Companies are judged on their levels of disclosures across more than 240 data points based on inputs provided in their sustainability reports / business responsibility reports / annual reports. Companies with higher disclosures get higher scores. Our disclosure scores are based on a binary scoring system (+1 for disclosure, 0 for non-disclosure). The total disclosure score is then standardized and ranges from 0 (least score) to 100 (highest score).
2) Qualitative checks (70% weight): We check for any past violations / red flags of certain E&S metrics and corporate governance regulations. Depending on the severity of the violation, negative points are given ranging from -10 (most severe violation) to 0 (no violation /no red flags). The total qualitative score ranges from 0 (highest score) to -100 (least score). In addition we also conduct checks to ensure adherence to our financial filters such as leverage, return on capital and growth.
Within disclosures and qualitative checks, Governance is given a 50% weight; Environmental and Social have a weight of 25% each.
ESG Research Process
Our research methodology focuses on evaluating companies on their disclosures and qualitative performance on environmental, social and governance aspects that we consider material to their operations. As an example, while climate change and emissions are a global concern, they are especially significant when evaluating investments in a thermal power plant as well as energy intensive industries. Similarly for companies in the food and beverage industry, responsible sourcing, water stewardship and ingredient safety would be material aspects to consider.
We have a five member team dedicated to ESG research. Each analyst is allocated certain sectors and has the responsibility of evaluating ESG practices of companies in our coverage belonging to his or her allocated sector.
The ESG research process typically involves the following steps -
Identification of material aspects: the ESG analyst gathers information from various sources (sustainability reports, annual reports, SASB publications) to identify key material aspects relevant to the industry. During this stage the ESG analyst also interacts with the financial research analyst to gain an understanding of the sector and the companies that are being researched.
Report preparation: Based on company disclosures and qualitative aspects and after an internal discussion in the ESG team, the companies are scored on their ESG performance.
Presentation to research team: The ESG analyst presents the report to the entire research team for their comments / feedback or clarifications.
Once agreed, the ESG scores are recorded in the database and used in future for the portfolio construction process.
Once an ESG score is assigned to a company it is the responsibility of the sector analyst to work with the ESG analyst on updating and reviewing the data to refresh the scores. Portfolio stocks are updated once every 6 months. Needless to say, if new controversies emerge, the ESG process is agile enough to reflect this in our scoring process.
Our process has evolved over last few years, as we travel up the learning curve and established a principles-based, qualitative-oriented, ESG framework. With disclosure standards expected to get a big fillip from 2021, based on regulatory norms, the overall assessment framework will further strengthen in the future.