How firms factor in environmental, social and corporate governance

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Sustainable investing incorporates environmental, social and governance considerations.

But how exactly do these factors fit into the analytical process, and how do they add value? CNBC consulted with several experts to find out.

In general terms, “we look at a company’s business models and where they operate geographically and assess what ESG factors they’re exposed to,” said Diederik Timmer, executive vice president with Sustainalytics, which provides ESG-related ratings and research on companies.

ESG factors do vary by company and industry.

For example, a financial institution can be exposed to concerns such as financial inclusion (providing access to the underserved), employee satisfaction and business ethics, he said. To see how well the company is managing these factors, Sustainalytics will look closely at the firm’s management systems and policies, how they report on outcomes and any negative press.

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It may seem odd at first to apply measurable values to societal issues, but it is possible. As examples, measurable social metrics for a company include employee turnover, diversity percentages and pay scale ratios, said Conor Platt, founder and CEO of Confluence Analytics, which aggregates ESG data and creates predictive performance metrics for individual companies and exchange-traded funds. These factors are then ranked against peer companies within their specific sector or industry.

“Any time you own a stock, you own thousands of data points, Platt said. “And for investors, ESG metrics are the best way to assess intangible asset risk.”

In recent years, more bond analysts have been paying attention to ESG factors, said Judy Wesalo Temel, senior vice president, director of credit research with asset manager Fiera Capital. Municipal bond ratings agencies have also been more focused on these factors, she added.

“Investors are always looking at bond proceeds, but they also want to know where exactly their money is going and ‘Can you find the data regarding overall long-term impacts of the bond?'” she said.

ESG analysis captures issues usually missed by standard credit analysis, such as climate impact and governance concerns (e.g., timeliness of issuers’ financial disclosure and budget process transparency), Temel said. ESG-related insights in turn shine a new light on municipal bonds.

“People buy [them] for preservation of principle, tax-exemption purposes and safety,” she added. “But beyond that, muni bonds are the original impact investment instruments.

“They build schools, roads, hospitals – all sorts of things that improve the human condition.”

 The challenges of ESG

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