GUIDANCE AND CASE STUDIES FOR ESG INTEGRATION: EQUITIES AND FIXED INCOME CFA Institute is a global community of more than 150,000 investment professionals working to build an investment industry where investors’ interests come first, financial markets function at their best, and economies grow. The United Nations-supported Principles for Responsible Investment (PRI) Initiative is an international network of investors working together to put the six principles for responsible investment into practice. Its goal is to under- stand the implications of Environmental, Social and Governance issues (ESG) for investors and support signatories to incorporate these issues into their investment decision making and ownership practices. In implementing the principles, signatories contribute to the development of a more sustainable global financial system. There are currently more than 2000 signatories to the PRI who collectively manage approximately US$80 trillion in assets. 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Contents Executive Summary 1 Case Study Table 3 The ESG Integration Framework 5 Research: The Inner Circle 6 Security Level: The Middle Circle 7 Portfolio Level: The Outer Circle 8 ESG Integration Overview 9 What is ESG Integration? 9 What ESG Integration Is Not 9 Qualitative Analysis versus Quantitative Analysis 11 Equity Investing versus Fixed Income Investing 12 ESG in Equity Analysis 15 ESG in Fixed-Income Analysis 17 Equity Case Studies 25 Evaluating ESG Impact on Revenue and Margins 26 ESG Integration in Action: Apollo Hospitals 30 Development of a Broader ESG Strategy for Godrej Group: Arisaig Partners’ Approach to ESG Criteria 33 A Framework to Incorporate Sustainability “Sustainably” for Quantitative Managers 37 Valuation Adjustment According to Environmental Regulations 42 Mitsubishi Motors Corporation 45 Navigating 21st-Century Business Risks and Opportunities 50 Using ESG Criteria to Assess Franchise Quality and Fair Value 53 © 2018 CFA INSTITUTE. ALL RIGHTS RESERVED. iii Contents New Perspectives under High-Quality Development Trend in China: A Case Study for Application of ESG Investment in the Agrochemical Industry 56 Strategically Aware Investing 60 How the “G” Factor Affects the Equity Valuation Model: A North American Software Company Case Study 64 Inequality, Outsourcing, and Indian IT Services Companies 67 Integration of Director Equity Participation in Company Valuation 71 Integrating ESG Factors Consideration into Equity Valuation 76 Aluminum Stock Carbon Price Case 80 Framing the Future Fortunes of a Global Diversified Miner Using an ESG Analysis Lens 83 ESG Investing in India: The Indian Agrochemicals Industry 87 Case Study: Fundamental Material ESG Scenario Analysis 92 ESG Equity Analysis Case Study 95 Ganesha Ecosphere Limited: An ESG Thematic Investment That worked for the SBI Mutual Fund 97 Fixed-Income Case Studies: Corporate Bonds 101 Integrating ESG Factors into Corporate Fixed-Income Investments 102 Credit Perspectives: ESG Integration in Practice—Petróleos Mexicanos 106 How to Invest Responsibly in Corporate Debt 110 Credit Risk Case Study: Agrokor 114 Integrating ESG in Corporate Credit Research 117 An ESG Credit Case Study 122 Beyond Ratings: Sustainability Integration in Fixed Income 126 Fixed-Income Case Studies: Sovereign Debt 131 Integration of ESG Factors into Sovereign Bonds: A Case Study of Russia 132 Responsible Investing in Debt Capital Markets: Unpacking Governance for State-Owned Entities 141 iv WWW.CFAINSTITUTE.ORG Contents Integrating ESG Factors into Sovereign Credit Research 148 Troubles in Turkey 152 Fixed-Income Case Studies: Municipal Bonds 155 The Challenges with and Lessons from Integrating ESG Issues into Municipal Bonds 156 Fixed-Income Case Studies: Structured Credit 161 Assessing ESG Factors in Structured Securities 162 © 2018 CFA INSTITUTE. ALL RIGHTS RESERVED. v This page is intentionally blank EXECUTIVE SUMMARY Portfolio managers and analysts are increasingly incorporating ESG factors into their investment analyses and processes. However, ESG integration remains in its relative infancy, with investors and analysts calling for more guidance on exactly “how” they can “do ESG” and integrate ESG data into their analysis. CFA Institute and Principles for Responsible Investment (PRI) set out to create a best- practice report (Guidance and Case Studies for ESG Integration: Equities and Fixed Income) and three regional reports [one for the Americas (AMER), one for Asia-Pacific (APAC), and one for Europe, the Middle East, and Africa (EMEA)] to help investors understand how they can better integrate ESG factors into their equity, corporate bond, and sovereign debt portfolios. We are able to achieve this goal by: ■ surveying 1,100 financial professionals, predominantly CFA members, around the world; ■ running 23 workshops in 17 major markets (see the table on the next page); ■ interviewing many practitioners and stakeholders; ■ publishing more than 30 case studies written by equity and fixed-income practitioners; ■ analyzing Bloomberg’s ESG company disclosure scores; and ■ reviewing data from the PRI reporting framework, the largest global database of information on investors’ ESG practices. This publication, Guidance and Case Studies for ESG Integration: Equities and Fixed Income, provides a global insight on the ESG integration techniques of leading practitio- ners across all regions of the world and includes case studies by analysts, portfolio man- agers, and investors, who share how they integrate ESG into their analysis and tell their stories of ESG integration. It also introduces an ESG Integration Framework that can be a reference for practitioners to use when comparing their ESG integration techniques with their peers’ ESG integration techniques and identify those techniques that are suit- able for their own firm. We hope the work presented here helps both equity and fixed-income investors to bet- ter understand the many ways in which they can integrate ESG analysis into their invest- ment decision making. © 2018 CFA INSTITUTE. ALL RIGHTS RESERVED. 1 Guidance and Case studies for ESG Integration: Equities and Fixed Income THE 17 MARKETS WHERE THE 23 ESG WORKSHOPS WERE HELD ESG WORKSHOPS ACROSS THE WORLD AMER APAC EMEA Brazil Australia France Canada China Germany United States Hong Kong Netherlands India Russia Japan South Africa Singapore Switzerland United Arab Emirates United Kingdom Abbreviations: AMER, Americas; APAC, Asia Pacific; EMEA, Europe, Middle East, and Africa. 2 WWW.CFAINSTITUTE.ORG CASE STUDY TABLE We collected more than 30 case studies to demonstrate many of the techniques found in the ESG integration framework (see the section “ESG Integration Framework”). The case studies were written by leading practitioners across 13 markets in the Americas, EMEA, and APAC regions. You can use the case study table provided below to help you navigate the case studies found in this volume. THE CASE STUDY TABLE DOMICILE OF FIRM PROVIDING SECTOR/COUNTRY ASSET CLASS PAGE THE CASE STUDY THE CASE STUDY AUTHOR Australia Alliance Bernstein L.P. Healthcare Equity 30 Brazil Santander Asset General Equity 95 Management Canada AGF Investments Inc. Chemicals Equity 26 Canada Manulife Asset Technology Equity 64 Management Canada RBC Global Asset Healthcare Equity 92 Management China E Fund Management Chemicals Equity 42 Co., Ltd. China Hwabao WP Fund Chemicals Equity 56 Management Co., Ltd. Hong Kong The Goldman Sachs Semiconductor Equity 50 Group, Inc. India Quantum Advisors Chemicals Equity 87 Private Ltd. India SBI Funds Management Waste Equity 97 Pvt. Ltd., India Management Japan Nissay Asset Management Industrials Equity 76 Corporation Netherlands NN Investment Partners Materials