Environmental, Social and Governance Integration in the Investment Process

The trend of sustainable investing has been growing globally over the last years and one of the most debated topic among investors is whether integrating Environmental, Social and Governance (ESG) issues in the investment process and portfolio construction has positive or negative effects on the financial performance. After analysing the historical evolution of Socially Responsible Investments (SRI) into Environmental, Social and Governance (ESG) investments, in the first chapter, this study proceeds to examine the current regulatory framework. The second part of the work deals with the different integration strategies of ESG factors. There are four common macro categories of integration strategies: negative screening, positive screening, active ownership and full integration. These strategies are employed in different ways according to different organisations. For instance, Eurosif divides sustainable investment strategies in seven categories, the Principles for Responsible Investing Association uses six categories and the European Fund and Asset Management Association identifies five categories of sustainable investment strategies. Despite having common characteristics, the comparison among these strategies is often very hard because of the way they are applied by each organization. A consequence of the development of sustainable investing was the establishment of new investment indices constituted by corporations with particular ESG characteristics . Some of these indices are briefly examined in this paper: the Dow Jones Sustainability Indices (DJSI), the FTSE4Good Index and the Morgan Stanley Capital International Indexes (MSCI). The third chapter goes more in depth in the discussion circa the advantages and disadvantages of including such strategies in the investment process and the impact that they have on a firm or portfolio performance. There is a common misconception that addressing environmental social and governance concerns merely represents a cost for companies that will inevitably impair shareholder value. This paper presents a review of several empirical studies, such as the one conducted by the UN Environmental Programme Financial Initiative jointly with Mercer, or the research performed by Morningstar Ratings, that come to the conclusion that sustainable investing produces positive outcomes or that, at a minimum, sustainable funds achieve a performance on a par with traditional funds. One of the most recent studies reviewed in this paper is the one conducted by Giese et al. (2019) concerning transmission channels form ESG to financial performance and the causality relationship between ESG ratings and companies’ valuations. Finally, the paper ends with a brief account of a landmark decision taken by the District Court of The Hague in the case Milieudefensie et al. v. Royal Dutch Shell plc. This decision marks the first time a corporation has been held 3 responsible for the reduction of net emissions in line with the goals set by the 2015 Paris Agreement.