Are you a Believer, a Fundamentalist, or a Statistician when it comes to environmental, social, and governance (ESG) investing?

Understanding the types of ESG investor there are can improve your matchmaking with managers or clients, according to research by Sustainalytics, an ESG research provider.

The research – commissioned by the Investor Responsibility Research Center Institute – presented six typologies summarising the approaches to ESG issues across the investment sector.

The research could help asset owners better discern and distinguish between asset managers’ approach to ESG integration, and which characteristics are the best fit for them, Sustainalytics said. Asset managers, meanwhile, could use it to review their approaches and decide whether they want to make changes.

The typology generated 64 different types of approaches, but the Sustainalytics researchers narrowed these down to six prevailing approaches to ESG integration, based on a dataset of 70 investors.

In Sustainalytics’ words, they are:

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The Believer: “Executes ESG integration in a manner that is clearly structured and consistent throughout an organisation. Integral to this approach is a top-down application of general (i.e. not based on security-specific fundamental analysis) assumptions about how certain ESG factors may affect value. It usually focuses on security-level ESG considerations as opposed to macro ESG trends.”

The Cautionary: “Seeks to ensure that investment teams consider ESG factors in order to improve risk management, focusing on company-specific research rather than broad ESG trends.”

The Statistician: “Uses statistical analysis to identify correlations between historical ESG performance and historical financial performance with the aim of identifying material factors that are likely to generate alpha. This analysis is built into models that are applied to passive or smart beta strategies.”

The Discretionary: “Considers ESG factors on an optional basis as a supplement to traditional financial analysis, usually with a focus on idiosyncratic risk management.”

The Transition-Focused: “Regards ESG factors as central research inputs, and concentrates to a significant degree on risks and opportunities associated with broad ESG-related economic shifts, ESG thematics and sustainability challenges.”

The Fundamentalist: “Aims to integrate ESG factors thoroughly into bottom-up analysis and decision-making by considering company-specific ESG factors as well as macro ESG trends that may affect company’s performance over short- and long-term time horizons.”

To define these six ESG personalities, Sustainalytics classified ESG integration approaches along three dimensions:

  • management (for the who of integration);
  • research (what is being integrated); and
  • application (how the integration is taking place)

Under the management heading, one differentiating factor the research highlighted was the degree of centralisation of ESG functions within an organisation, i.e. whether ESG responsibilities were assigned to dedicated ESG personnel or carried out by portfolio managers and analysts in portfolio management teams.

Under ‘research’ were those integrating macro-level sustainability trends and themes, such as climate change and water scarcity, as opposed to certain ESG-relevant characteristics of individual companies and securities.

‘Actual’ integration questionable

However, the actual state of ESG integration was unclear, according to the researchers.

“The analysis of investors’ management of ESG integration suggests that there may be less actual integration taking place than expected by the market,” the report authors wrote.  

For example, some of the investors interviewed were “candid” about their organisations lacking an information trail or reporting system to demonstrate how frontline investment decision-makers use ESG research.

“This might mean that portfolio managers are not fully utilising the ESG research that they have access to, even at organisations that have publicly expressed support for ESG integration,” the authors said. 

It could also be the case, however, that organisations that have not made public commitments to ESG could be implementing “genuine” integration, they added.

Investors interviewed for the report also suggested that meaningful integration of ESG information remained fundamentally challenging. Mandate design, meanwhile, could constrain ESG integration, for example if tracking error limits are imposed. 

The authors expressed hope that these and other findings would “stimulate discussion about the state of the industry and some of the challenges and opportunities associated with ESG integration”. 

The full report can be found here.