11_trader_1BUS3600_CFA_PRI_Integration_ESG.pdf

THE ESG INTEGRATION FRAMEWORK After extensive analysis of the ESG integration techniques of direct investors across the globe, CFA Institute and PRI collated the many ESG integration techniques used by practitioners and developed the ESG Integration Framework (see Figure 1). FIGURE 1: THE ESG INTEG...

THE ESG INTEGRATION FRAMEWORK After extensive analysis of the ESG integration techniques of direct investors across the globe, CFA Institute and PRI collated the many ESG integration techniques used by practitioners and developed the ESG Integration Framework (see Figure 1). FIGURE 1: THE ESG INTEGRATION FRAMEWORK IS YS AL N A RI SK ESG and financial risk exposures and limits analysis Internal credit assessment SE CU RI TY Forecasted financials & ratios Valuation multiples S E CU R I T Tactical asset allocation Relative ranking ESG-integrated Centralized research research note dashboard Forecasted financial ratios ESG agenda at (committee) meetings Materiality framework SWOT analysis VA OME INC ED FIX N— IO AT LU RESEARCH ESG INTEGRATION Y VA T LUA ASS IO N ET A — EQ Valuation-model variables Company questionnaires Duration analysis UI ESG profile (vs. benchmark) TI ES TIO CA LLO Red-flag indicators Value-at-risk analysis Relative value analysis/ spread analysis Voting Individual/ collaborative engagement Internal ESG research Watch lists M AN AG T EN EM O RI NA E SC Portfolio scenario N Security sensitivity/ scenario analysis EQ U I TIE S /FI XE Portfolio weightings Research level Security level C D IN OM E TFO POR I CT RU O N Strategic asset allocation Forecasted financials LI ON OC ST Porfolio level © 2018 CFA INSTITUTE. ALL RIGHTS RESERVED. 5 Guidance and Case studies for ESG Integration: Equities and Fixed Income The ESG Integration Framework is not meant to illustrate the perfect ESG-integrated investment process. Rather, the ESG Integration Framework is meant to be a reference so that practitioners can analyze their peers’ ESG integration techniques and identify those techniques that are suitable for their own firm. We believe that this will be a useful resource and reference as you develop your ESG-integrated investment process over time. As every firm is unique, the ESG integration techniques of one firm are not necessarily the right techniques for all firms. We recommend you refer to the ESG Integration Framework as you read this report as well as the “Investment Practices of Local Practitioners” subsections of each regional report. RESEARCH: THE INNER CIRCLE Qualitative Analysis ■■ ■■ ■■ ■■ ■■ ■■ ■■ ■■ ■■ 6 Company questionnaires: Questionnaires sent to companies to collect more ESG data and information where the company’s level of public ESG disclosure is inadequate. These questionnaires are also used in parallel with regular company meetings, where investors and companies will meet to discuss the most material ESG issues. Red-flag indicators: Securities with high ESG risk are flagged in lists, research notes, dashboards, and databases. Watch lists: Securities with high ESG risk are added to a watch list for regular monitoring. Internal ESG research: Based on a variety of data sources, proprietary ESG research/views/scores are created for all securities in the portfolio and investment universe. SWOT analysis: ESG factors are included in the traditional SWOT (strengths, weaknesses, opportunities, and threats) analysis. Materiality framework: A materiality/sustainability framework is created that includes all the key ESG risks and opportunities for each sector/country. This framework is referred to when making investment decisions and is regularly updated. ESG-integrated research note: Research notes/credit notes consist of traditional financial information and analysis and ESG information and analysis. Centralized research dashboard: Traditional financial data and ESG data are kept on one platform (dashboard/database) so practitioners can analyze concurrently traditional financial factors and ESG factors. ESG agenda at (committee) meetings: Investment teams (and possibly ESG teams/ specialists) have a dedicated ESG item on all agendas of investment team meetings. Committees meet to discuss ESG strategy, ESG performance of portfolios, and/or controversial securities. WWW.CFAINSTITUTE.ORG The ESG Integration Framework Active Ownership Voting: This structured process captures all voting rights and applies a rigorous analysis to management and shareholder resolutions before casting votes. In addition to being used for voting, this process can be employed to submit resolutions on which other shareholders may vote. ■■ Individual/collaborative engagement: Engagement captures any interactions between the investor and current or potential investee companies on ESG issues and relevant strategies, with the goal of improving (or identifying the need to influence) ESG practices and/or improving ESG disclosure. It involves a structured process that includes dialogue and continuously monitoring companies. These interactions might be conducted individually or jointly with other investors. ■■ SECURITY LEVEL: THE MIDDLE CIRCLE Security Valuation—Equities ■■ ■■ ■■ ■■ ■■ Forecasted financials: Adjustments are made to forecasted financials (e.g., revenue, operating cost, asset book value, capital expenditure) for the expected impact of ESG factors. Valuation-model variables: Adjustments are made to valuation-model variables (e.g., discount rates, perpetuity growth, terminal value) for the expected impact of ESG factors. Valuation multiples: Adjustments are made to valuation multiples to calculate “ESG-integrated” valuation multiples. These multiples are then used to calculate the value of securities. Forecasted financial ratios: Forecasted financials and future cash flow estimates are adjusted for ESG analysis and the effect on financial ratios is assessed. Security sensitivity/scenario analysis: Adjustments are made to variables (sensitivity analysis) and different ESG scenarios (scenario analysis) are applied to valuation models to compare the difference between the base-case security valuation and the ESG-integrated security valuation. Security Valuation—Fixed Income ■■ Credit analysis o Internal credit assessments: ESG analysis is used to adjust the internal credit assessments of issuers. o Forecasted financials and ratios: Forecasted financials and future cash flow estimates are adjusted for ESG analysis and the effect on financial ratios is assessed. o Relative ranking: ESG analysis impacts the ranking of an issuer relative to a chosen peer group. © 2018 CFA INSTITUTE. ALL RIGHTS RESERVED. 7 Guidance and Case studies for ESG Integration: Equities and Fixed Income Relative value analysis/spread analysis: An issuer’s ESG bond spreads and its relative value versus those of its sector peers are analyzed to find out if all risk factors are priced in. ■■ Duration analysis: The impact of ESG issues on bonds of an issuer with different durations/maturities is analyzed. ■■ Security sensitivity/scenario analysis: Adjustments to variables (sensitivity analysis) and different ESG scenarios (scenario analysis) are applied to valuation models to compare the difference between the base-case security valuation and the ESG-integrated security valuation. ■■ PORTFOLIO LEVEL: THE OUTER CIRCLE Risk Management ESG and financial risk exposures and limits: Companies, sectors, countries, and currency are regularly reviewed and monitored for changes in ESG risks and opportunities and for breaches of risk limits. ■■ Value-at-risk analysis: ESG analysis feeds into value-at-risk models. ■■ Portfolio scenario analysis: Different ESG scenarios are run to assess the impact of ESG factors on portfolio risk and return. ■■ Portfolio Construction ESG profile (versus benchmark): The ESG profile of portfolios is examined for securities with high ESG risks and assessed relative to the ESG profile of a benchmark. ■■ Portfolio weightings: Adjustments are made to weightings of companies, sectors, countries, and/or currency in a portfolio to mitigate ESG risk exposures and avoid breaching ESG risk limits and other risk limits. ■■ Portfolio scenario analysis: Different ESG scenarios are run to assess the impact of ESG factors on portfolio risk and return. ■■ Asset Allocation Strategic asset allocation: Strategic asset allocation (SAA) strategies factor in ESG objectives and analysis to progressively mitigate the ESG risks and enhance financial performance. ■■ Tactical asset allocation: Tactical asset allocation (TAA) strategies factor in ESG objectives and analysis to mitigate short-term ESG risks. ■■ Portfolio scenario analysis: Different ESG scenarios are run to assess the impact of ESG factors on SAA strategies and TAA strategies. ■■ 8 WWW.CFAINSTITUTE.ORG ESG INTEGRATION OVERVIEW WHAT IS ESG INTEGRATION? ESG practitioners use multiple acronyms, terms, and practices when they talk about ESG integration. This makes it difficult for non-ESG practitioners to know if they are performing ESG integration. Terms such as sustainable investing, ESG investing, socially responsible investing (SRI), green investing, ethical investing, and impact investing are often used interchangeably. In this volume, ESG integration is defined as “the explicit and systematic inclusion of ESG factors in investment analysis and investment decisions.” It is a holistic approach to investment analysis, where material factors—ESG factors and traditional financial factors—are identified and assessed to form an investment decision. ESG integration typically has three components: 1. Research: o Information gathering: Practitioners gather financial and ESG information from multiple sources (including but not limited to company reports and third-party investment research). o Materiality analysis: Practitioners analyze relevant financial and ESG information to identify material financial and ESG factors affecting a company, sector, and/or country. o Active ownership assessment: Practitioners discuss material traditional financial factors and ESG factors with companies/issuers and monitor the outcome of engagement and/or voting activities. 2. Security and portfolio analysis: Practitioners assess the impact of material financial and ESG factors on the corporate and investment performance of a company, sector, country, and/or portfolio. This can lead to adjustments to their forecasted financials, valuation-model variables, valuation multiples, forecasted financial ratios, internal credit assessments, and/or portfolio weightings (see “Qualitative Analysis versus Quantitative Analysis” for more information). 3. Investment decision: The material traditional financial factors and ESG factors identified and assessed influence a decision to either buy/increase weighting, hold/maintain weighting, sell/decrease weighting, or do nothing/not invest. WHAT ESG INTEGRATION IS NOT ESG integration does not mean that: investment in certain sectors, countries, and companies is prohibited; portfolio returns are sacrificed to perform ESG integration techniques; immaterial ESG factors affect investment decisions and traditional financial factors are ignored; or ■■ major changes to your investment process are necessary. ■■ ■■ ■■ © 2018 CFA INSTITUTE. ALL RIGHTS RESERVED. 9 Guidance and Case studies for ESG Integration: Equities and Fixed Income ESG Integration Does Not Prohibit Investing in Certain Companies, Sectors, or Countries Some practitioners believe that ESG integration and exclusionary screening are one and the same. However, these practices have two fundamental differences: ■■ ■■ One approach potentially reduces the investment universe; the other does not. One approach is a “values” approach; the other is a “value” approach. Exclusionary screening is implemented through a screening policy that reduces the investment universe. The policy is applied at either the firm or the fund level and includes: ■■ ■■ a list of prohibited practices, products, and/or services; and rules that identify countries, sectors, and companies in which investment is prohibited. Typically, exclusionary screening is implemented before any investment analysis takes place. This is contrary to ESG integration, where financial information and ESG information are embedded in the security selection and portfolio construction process and all companies, sectors, and/or countries in the investment universe can be bought and sold. Portfolio Returns Are Not Being Sacrificed to Perform ESG Integration Techniques A key component of ESG integration is lowering risk and/or enhancing returns. Practitioners apply ESG integration techniques to uncover hidden risks that might remain undiscovered without the analysis of ESG information and ESG trends. ESG practitioners also look for investment opportunities to enhance returns. For example, some practitioners analyze automotive companies to see how they are reacting to trends in car electrification and factor this assessment into their revenue forecasts. Another example is practitioners who invest in companies with strong ESG management that are likely to outperform their competitors in the long run. Immaterial ESG Issues Do Not Affect Investment Decisions Another key component of ESG integration is materiality. Practitioners assess all material factors—traditional financial factors as well as ESG factors—to identify investment risks and opportunities that are considered highly likely to affect corporate performance and investment performance: If traditional financial and ESG factors are analyzed and found to be material, an assessment of their impact is carried out. ■■ If traditional financial and ESG factors are analyzed and found not to be material, an assessment is not carried out. ■■ 10 WWW.CFAINSTITUTE.ORG ESG Integration Overview Practitioners assess several factors when judging whether ESG issues are material, including the following: 1. Sector and country considerations: Material ESG issues are commonly associated with certain sectors and countries. They include regulatory and technological changes associated with the business activity that the companies in a sector are involved in or the markets to which they source or sell. 2. Company considerations: Material ESG issues related to a sector may not be valid for all companies in the sector because: o material ESG issues of a company’s business lines unrelated to the sector could outweigh material ESG issues of business lines related to the sector; o a company’s products and/or services that benefit from ESG trends could mitigate or outweigh the ESG risk associated with its sector; or o a company’s strong environmental and social management and good governance could mitigate the ESG risk associated with its sector. 3. Time-frame considerations: Practitioners who are long-term investors are likely to integrate ESG factors more regularly than short-term investors, as ESG factors tend to be low-frequency, high-impact factors that drive long-term performance. No Major Changes Are Needed to Investment Processes and Practices ESG integration is a useful complement to practitioners’ current investment process and practices. The main addition to practitioners’ process is the sourcing and analyzing of ESG information, which is necessary to understand the top ESG issues affecting a company, sector, or country. Some practitioners develop new valuation models to include ESG information. Others feed ESG information into their existing models. QUALITATIVE ANALYSIS VERSUS QUANTITATIVE ANALYSIS ESG integration is commonly implemented by using approaches and analysis that are more qualitative than quantitative. Increasingly, however, practitioners are quantifying and integrating ESG issues into their company/issuer valuations. Some examples of practitioner use of qualitative analysis of ESG issues to inform investment decisions include the following: ■■ The ESG analysis of a company or country is studied alongside the investment analysis of that company or country to inform a “buy/sell/hold/don’t invest” decision. For example, if a company or country is viewed poorly based on its ESG performance and on its valuation assessment, it could lead to a “sell” or “don’t invest” signal. If the same company or country is rated poorly on its ESG performance but well on its valuation assessment, it could lead to a deeper analysis of the company or country before a decision is made. © 2018 CFA INSTITUTE. ALL RIGHTS RESERVED. 11 Guidance and Case studies for ESG Integration: Equities and Fixed Income The ESG analysis can be the deciding factor between otherwise identical companies or countries. If all other factors are equal, the practitioner will choose the company or country that performs better on its ESG analysis. ■■ Practitioners invest in undervalued securities that have an opportunity to outperform based on improving ESG performance and divest from overvalued securities that could underperform based on deteriorating ESG performance. ■■ If a company has a low ESG score/assessment on certain ESG factors, engagement with the company can improve those factors, resulting in a buy/hold decision. ■■ The ESG analysis can influence the maturity of the bond that an investor purchases. ■■ Some examples of practitioner use of quantitative analysis of ESG issues to inform investment decisions include the following: ■■ ■■ ■■ ■■ ■■ ■■ ■■ ESG analysis of a company or country leads to an adjustment of its internal credit assessment. Temporary upward/downward adjustments to forecasted financials, valuationmodel variables, valuation multiples, forecasted financial ratios, and/or portfolio weightings are made for ESG analysis/ESG scores through sensitivity analysis. Permanent upward/downward adjustments to forecasted financials, valuationmodel variables, valuation multiples, forecasted financial ratios, and/or portfolio weightings are made for ESG analysis/ESG scores. Adjustments to forecasted financials, valuation-model variables, valuation multiples, forecasted financial ratios, and/or portfolio weightings are made through scenarios. ESG data/analysis is used as a factor in quant models/factor investing that impact portfolio construction decisions. Statistical techniques are used to identify the relationship between an ESG factor(s) and/or aggregated ESG score, and future asset price movements and/or company fundamentals. This can result in systematic rules that lead to portfolio-weighting recommendations. The beta of bonds with lower/higher levels of ESG risk is adjusted downward/ upward so that the amount investors are able to hold in their portfolios could be more/less than previously calculated. EQUITY INVESTING VERSUS FIXED INCOME INVESTING Investment Practices Currently, fixed-income practitioners practice ESG integration less than their equity practitioner counterparts. The CFA-PRI survey, which ran from 2017 to 2018,1 showed that a higher percentage of all respondents are often/always integrating governance issues, environmental issues, and social issues into their equity analysis, compared to the percentage CFA Institute and Principles for Responsible Investment (PRI) commissioned the firm YouGov to administer a global survey on ESG integration. The survey asked questions to gauge investor attitudes toward ESG integration as well as to obtain a better understanding of how ESG integration is done in practice. 1 12 WWW.CFAINSTITUTE.ORG ESG Integration Overview TABLE 1: RESPONDENTS WHO OFTEN/ALWAYS INTEGRATE MATERIAL ESG ISSUES INTO THEIR INVESTMENT ANALYSIS EQUITY ANALYSIS CREDIT ANALYSIS Governance Issues 56% 42% Environmental Issues 37% 27% Social Issues 35% 27% of respondents who are often/always integrating governance issues, environmental issues, and social issues into their credit analysis (see Table 1). This result may not come as a surprise. The first application of responsible investment practices—predominantly divestment and voting practices—were to fundamental equity strategies. ESG integration in equities started gaining momentum at the beginning of the 21st century, while ESG integration in fixed income is still in its infancy, although expanding rapidly. As a result, most asset owners and investment managers look to integrate ESG issues into their equity portfolios and funds before turning to their fixed-income portfolios and funds. The belated development of ESG integration in fixed income reflects a previously widespread view that ESG integration and fixed income are incompatible, based on arguments such as the following: The inherent complexity of bond markets—given the greater size of the market, variety of instrument types, maturities, and issuing entities—makes it harder to integrate ESG issues into credit risk assessments, especially when assessing interest rate risk and liquidity risk. ■■ Corporate bondholders can’t vote, and find it harder to effectively engage due to limited access to management (bondholders do not have a formal communication process such as the annual general meeting), while sovereign debtholders find it harder to effectively engage with sovereign debt issuers such as governments. ■■ ESG factors impact bond prices less frequently because: o low liquidity in the credit market (especially compared to equity markets) makes it hard to buy or sell bonds based on news of ESG controversies; and o traditional financial factors (interest rates, inflation, etc.) have the overriding influence on prices and therefore it is not necessary to analyze ESG issues. ■■ These views are gradually changing as an increasing number of practitioners incorporate ESG issues into fixed-income portfolios and funds. Of course, fixed-income practitioners still can’t vote, but they do engage2. Portfolio managers and credit analysts regularly contact companies and meet management in person, sometimes with their firm’s equity portfolio managers and equity analysts, and at roadshows. However, it is still rare for a PRI (2018). ESG Engagement for Fixed Income Investors—Managing Risks, Enhancing Returns. https://www.unpri. org/fixed-income/esg-engagement-for-fixed-income-investors-managing-risks-enhancing-returns-/2922.article 2 © 2018 CFA INSTITUTE. ALL RIGHTS RESERVED. 13 Guidance and Case studies for ESG Integration: Equities and Fixed Income group of fixed-income practitioners to engage with companies collaboratively and for fixed-income practitioners to engage with sovereign debt issuers. In fixed income, a key application of ESG data is to inform the analysis of issuer creditworthiness. Some practitioners have integrated ESG factors into their interest rate risk analysis when assessing bonds with varying maturities issued by the same issuer. For some issuers, the material ESG factors associated with a five-year bond will differ from those associated with a ten-year bond. That practitioners are now integrating ESG factors into their fixed-income analysis suggests they do believe that ESG factors can be material and therefore can affect bond returns. The CFA-PRI survey supports this conclusion. Table 2 shows that survey respondents believe that ESG issues are impacting share prices, corporate bond prices, and sovereign debt prices and will do so even more frequently in five years’ time (2022). TABLE 2: THE IMPACT OF ESG ISSUES IN 2017 AND THE EXPECTED IMPACT IN FIVE YEARS’ TIME (2022) ON SHARE PRICES, CORPORATE BOND YIELDS/SPREADS, AND SOVEREIGN DEBT YIELDS AFFECTED IN 2017 WILL AFFECT IN 2022 Governance 58% 65% Environmental 23% 52% Social 23% 46% Governance 41% 53% Environmental 15% 40% Social 15% 35% Governance 35% 44% Environmental 12% 31% Social 18% 32% ESG ISSUES IMPACT ON SHARE PRICES ESG ISSUES IMPACT ON CORPORATE BOND YIELDS/SPREADS ESG ISSUES IMPACT ON SOVEREIGN DEBT YIELDS Note: Percentages represent respondents who answered “often” or “always.” 14 WWW.CFAINSTITUTE.ORG ESG Integration Overview ESG Issues Table 2 also shows that across governance issues, environmental issues, and social issues, practitioners believe that these issues are impacting share prices more often than bond prices. Some arguments that practitioners have used to back these results include the following: 1. Share prices are more reactive to news flow and market sentiment than bond prices. When an ESG controversy that impacts a company becomes public knowledge, the effect on the company’s share price is greater than the effect on the company’s bond prices. 2. The equity market is more liquid and has higher volatility than the credit market. Thus, ESG factors have a more immediate impact on share prices than bond prices. 3. Client demand is higher for equity products with ESG mandates. Therefore, asset flows drive share prices more than bond prices. 4. The upside potential of bonds is limited, which can act as a buffer to bond price movements. 5. Macroeconomic factors, in particular interest rates, are key drivers of bond prices and override the impact of ESG issues. 6. Due to the fixed-income market’s size, variety of instrument types, maturities, capital structure positioning, and issuing entities, ESG factors impacting an issuer may manifest themselves differently depending on the bond characteristics. When comparing the figures for corporate bonds and sovereign debt, the results suggest that environmental, social, and governance issues impact sovereign debt prices less frequently than corporate bond prices, but only slightly. Interestingly, social issues are considered to be impacting sovereign debt yields more frequently than environmental issues both in 2017 and in 2022. Social and environmental issues are considered to impact share prices and corporate bond yields/spreads at roughly the same frequency now but by 2022, environmental issues will impact more frequently than social issues. ESG IN EQUITY ANALYSIS Typically, ESG practitioners apply qualitative ESG analysis to inform investment decisions. They use internal and third-party research to create individual proprietary scores for environmental issues, social issues and governance issues, which are also weighted to create an aggregate ESG score for each company in the portfolio and in the investible universe. Several ESG practitioners hold regular ESG-dedicated meetings to discuss these proprietary scores and their accompanying analysis to assess the potential impact of ESG issues on corporate performance and investment performance of companies and sectors. © 2018 CFA INSTITUTE. ALL RIGHTS RESERVED. 15 Guidance and Case studies for ESG Integration: Equities and Fixed Income Systematic Strategies—Quant Strategies and Smart Beta Strategies Although ESG integration has historically been associated only with fundamental strategies, quant and smart beta strategies are now integrating ESG factors into their valuation models and investment decisions. As ESG data become more prevalent, statistically accurate, and comparable, more managers are likely to perform statistical techniques to identify correlations between ESG factors and price movements that can generate alpha and/or reduce risk. The quant managers who perform ESG integration have constructed models that integrate ESG factors alongside other factors, such as value, size, momentum, growth, and volatility. ESG data are included in their investment processes and could result in upward or downward adjustments to the weights of securities, including to zero. Quant and smart beta strategies use two main approaches when integrating ESG factors into quantitative models. These approaches involve adjusting the weights of: securities ranked poorly on ESG to zero, based on research that links ESG factors to investment risk and/or risk-adjusted returns; and ■■ each security in the investment universe, according to the statistical relationship between an ESG dataset and other factors. ■■ Fundamental Strategies Buy-side fundamental practitioners and sell-side brokers integrate ESG factors, together with all other material factors, into their absolute and relative valuation models. They indicate their views on the impact of ESG factors and traditional financial factors on company valuations by adjusting future revenue growth rates, future operating costs, future capital expenditures, discount rates, terminal value, and other variables. Revenue To forecast revenue, practitioners typically take a view on how fast the industry is growing and whether the specific company will gain or lose market share. They integrate ESG factors into these forecasts by increasing or decreasing the company’s revenue growth rate(s) by an amount that reflects the level of investment opportunities or risks. Operating Costs, Operating Margin, and EBIT Margin Practitioners make assumptions about the influence of ESG factors on future operating costs and either adjust them directly or adjust the operating profit margin/earnings before interest and taxes (EBIT) margin. They may forecast some operating costs explicitly but, depending on the level of disclosure by companies, may find it necessary to make adjustments to the operating margin instead. For example, a practitioner may reduce future operating costs of a company due to a variety of initiatives that will reduce the company’s energy consumption and reliance on fossil fuels. 16 WWW.CFAINSTITUTE.ORG ESG Integration Overview Book Value and Impairment Charge ESG factors can influence assets’ anticipated cash flow, such as by forcing long-term or permanent closure, and therefore alter the net present value of the assets. The impact is most likely to be a reduction, resulting in an impairment charge being made to bring the company’s book value down accordingly, and therefore reducing not only the asset value but also the company’s earnings for the year in which the noncash, one-off impairment charge is recorded on the income statement. Capital Expenditure A practitioner may believe that ESG factors will lead a company to decrease or increase its future capital expenditure. Terminal Value ESG factors could cause practitioners to believe that a company or its business line will not exist forever. In these cases, the practitioner might reduce the terminal value to a lower value or to zero, respectively. Beta and Discount Rate Adjustment Some practitioners adjust the beta or discount rate used in company valuation models to reflect ESG factors. This technique is ideal when there is an apparent ESG risk to the company, but it is difficult to price it into the company’s valuation. One approach used by practitioners is to run a peer analysis of companies within the sector and then rank them by an ESG factor(s). The practitioner can then increase/decrease the beta/discount rate for companies considered to possess high/low ESG risk, in turn reducing/increasing the fair value. ESG IN FIXED-INCOME ANALYSIS Originally, corporate bond practitioners adapted the materiality/sustainability frameworks and ESG techniques used by the equity practitioners in their firms. This approach still happens and is relevant today. More recently, ESG integration techniques applied by fixed-income practitioners have become more sophisticated; some practitioners have fully adapted their processes and analysis to integrate ESG factors. Additional aspects should be considered when analyzing ESG risks and opportunities in fixed-income investing as compared to equity investing. Bonds come in all shapes and sizes, with differing issuer types, credit quality, duration, payment schedules, embedded options, seniority, currencies, and collateral. Bond prices are strongly influenced by fundamentals, macroeconomic factors, interest rates, and liquidity, which require a multilayered analysis of credit risk, interest rate risk, yield curve risk, and liquidity risk. All these variables require a sound understanding of how ESG issues can affect a bond. For example, due to the long-term nature of ESG risks, short-dated bonds issued © 2018 CFA INSTITUTE. ALL RIGHTS RESERVED. 17