Analysis of environmental, social and governance (ESG) issues and risks has often been painted as a niche offering separate from traditional portfolio building.

In reality, it’s best to assess ESG factors as part of a flexible and integrated process, according to two sustainable finance experts who led a masterclass on advanced ESG analysis at the Responsible Investment Association’s 2020 virtual conference.

What’s important is “the integration of the ESG aspect into portfolio management; it’s not just something you do separately [and] should be employed alongside what you’re doing already,” said Sean Cleary, a professor of finance at Smith School of Business, Queen’s University, and a director of the school’s Institute for Sustainable Finance.

Plus, responsible investment (RI) research should involve the use of several tools, Cleary noted. Investment managers can use their firm’s internal research, industry reports from responsible investment organizations, and direct engagement with companies.

What’s challenging is measuring and presenting ESG risks in a tangible way to clients, and even to companies with which a portfolio manager might be engaging.

“The issue that’s come up again and again is the financial industry has really outdone itself with the creation of acronyms and jargon, and there is no absolute ESG truth,” said Aaron Bennett, managing director of sustainable investment strategies and research at Montreal-based global investment firm Jarislowsky Fraser.

But that’s okay, he added: “There’s been a lot of discussion around the need for [ESG data] standardization. We’re an institution that doesn’t believe in total standardization,” even while there’s value “around standard frameworks and definitions.”

Bennett pointed to groups like the Sustainability Accounting Standards Board (SASB) and the Task Force on Climate-related Financial Disclosures (TCFD), as well as New York-based MSCI Inc. and Netherlands-based Sustainalytics, as examples of organizations that provide guidance.

However, Bennett demonstrated that the ESG scores from MSCI and Sustainalytics did not always correlate, for example, for Canadian equity fund holdings.

The main reason for differences among firms’ analyses is that “different systems and data points are designed for different stakeholders,” Bennett said. “You always need to be critically assessing [ESG] data for things such as alignment with your investment process and beliefs, as well as quality and consistency.”

At Jarislowsky Fraser, which manages $40 billion in assets and uses a bottom-up approach, he said managers incorporate ESG research into their modelling, stock selection and portfolio processes.

Bennett says ESG data and processes should have four characteristics: material or relevant to the companies being assessed (and to the clients you’re working with); consistent; adaptable; and systemic — so processes can then be effectively applied across various markets and strategies.

His firm assesses 13 broad ESG areas across many different types of companies, from resource-use intensity in the environmental lens to culture and risk management in the governance and social lenses, respectively.

His firm would look at resource use for both an energy company and a fast food chain, for example, but would drill into different underlying issues for each. For an energy name, there’s direct climate change risk and how they use and dispose of resources. For a fast-food name, the firm looks instead at sustainable farming and supply chain transparency.

The firm reviews issues over the short and long terms using a “business practice scorecard,” Bennett said. “But it’s not about getting an A. This is about ensuring that potential, material [ESG] issues have been discussed.”

In general, he said, “You want to avoid the checklist side of things but still ensure you’re being systematic enough that someone could come in and understand the framework.”

An additional tip from Bennett was that looking at how companies deal with taxation is key.

This factor “is not often related to E, S and G, but really is quite important” since it relates to the balance sheet, he said. Bennett refers to the balance sheet as “where you can really see the opportunities and the risks that accumulate over time.”

Cleary agreed that strong ESG analysis comes down to quality. “It’s not the amount of information or the number of sustainability reports [that matters], although that’s improving and that’s good,” he said.

A June 2020 report from the Investment Funds Institute of Canada (IFIC) similarly highlights that there’s “some debate and confusion” over ESG analysis best practices.

Citing external research from 2018 and 2019, IFIC indicated that more investors seem to be using informal evaluation of ESG factors over “methodical” approaches.

The report said concerns remain around the consistency, transparency, relevance and quality of RI data, though it also highlighted the work being done by SASB, TCFD and the United Nations as positive drivers.