GUIDANCE AND CASE STUDIES
FOR ESG INTEGRATION:
EQUITIES AND FIXED INCOME

CFA Institute is a global community of more than 150,000 investment 
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iii
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
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

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iv
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
Altice: 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

v
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
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

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1
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
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.

Guidance and Case studies for ESG Integration: Equities and Fixed Income
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2
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.

3
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
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 
THE CASE STUDY 
AUTHOR
FIRM PROVIDING  
THE CASE STUDY 
SECTOR/COUNTRY
ASSET CLASS
PAGE
Australia
Alliance Bernstein L.P.
Healthcare
Equity
30
Brazil
Santander Asset 
Management
General
Equity
95
Canada
AGF Investments Inc.
Chemicals
Equity
26
Canada
Manulife Asset 
Management
Technology
Equity
64
Canada
RBC Global Asset 
Management
Healthcare
Equity
92
China
E Fund Management  
Co., Ltd.
Chemicals
Equity
42
China
Hwabao WP Fund 
Management Co., Ltd. 
Chemicals
Equity
56
Hong Kong
The Goldman Sachs  
Group, Inc.
Semiconductor
Equity
50
India
Quantum Advisors  
Private Ltd.
Chemicals
Equity
87
India
SBI Funds Management 
Pvt. Ltd., India
Waste 
Management
Equity
97
Japan
Nissay Asset Management 
Corporation
Industrials
Equity
76
Netherlands
NN Investment Partners
Materials
Equity
80
(Continued)

Guidance and Case studies for ESG Integration: Equities and Fixed Income
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4
THE CASE STUDY TABLE (CONTINUED)
DOMICILE OF 
THE CASE STUDY 
AUTHOR
FIRM PROVIDING  
THE CASE STUDY 
SECTOR/COUNTRY
ASSET CLASS
PAGE
Netherlands
Robeco
Telecoms
Corporate bond
122
Netherlands
Robeco
Turkey
Sovereign debt
152
Singapore
Arisaig Partners
Consumer 
Products
Equity
33
Singapore
AXA Investment Managers 
Asia (Singapore) Ltd.
Software
Equity
37
Singapore
Eastspring Investments
Automotive
Equity
45
South Africa
Momentum Investments
Property
Equity
71
South Africa
Old Mutual Investment Group
Mining
Equity
83
South Africa
Futuregrowth Asset 
Management  (PTY) Ltd. 
South African  
SOEs
Sovereign debt
141
Switzerland
UBS Asset Management
Multiple
Corporate bond/ 
Sovereign debt
126
United Kingdom
Inflection Point Capital 
Management
Chemicals
Equity
60
United Kingdom
Hermes Investment 
Management
Oil & Gas
Corporate bond
106
United Kingdom
Insight Investment
Technology
Corporate bond
110
United Kingdom
Man GLG
Food Retailer
Corporate bond
114
United Kingdom
Colchester Global Investors
Russia
Sovereign debt
132
United Kingdom
PIMCO
South Africa
Sovereign debt
148
United States
High Pointe Capital 
Management
General
Equity
53
United States
MFS Investment 
Management
IT Outsourcing
Equity
67
United States
Breckinridge Capital 
Advisors
Beverage
Corporate bond
102
United States
Sage Advisory Services, 
Ltd. Co. 
Utilities
Municipal bond
156
United States
Angel Oak Capital Advisors, 
LLC
Financials
Structured credit
162
United States
PIMCO
Financials
Corporate bond
117

5
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
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
ASS
ET 
ALL
OCA
TIO
N 
 
 
 
 
 
 
 
POR
TFO
LIO
 CO
NST
RUC
TIO
N
SCE
NA
RIO
 AN
ALY
SIS
  
 
 
 
 
      
      
   R
ISK
 MA
NAG
EM
ENT
 
 
 
 
 
 
 
SE
CU
RIT
Y V
AL
UA
TIO
N—
FIX
ED
 IN
CO
ME
SE
CU
RIT
Y V
AL
UA
TIO
N—
EQ
UIT
IE
S   
     
    
    
EQ
UIT
IE
S/
FIX
ED
 IN
CO
ME
ESG-integrated
research
note
Materiality
framework
Centralized
research
dashboard
ESG agenda at
(committee)
meetings
Voting
Individual/
collaborative
engagement
Company
questionnaires
Red-flag
indicators
ESG
INTEGRATION
Watch lists
Internal ESG
research
SWOT analysis
Valuation
multiples
Valuation-model
variables
Forecasted
financials
Security sensitivity/
scenario analysis
Duration
analysis
Relative
value
analysis/
spread
analysis
Relative
ranking
Forecasted
financials & ratios
Internal credit
assessment
Forecasted
financial
ratios
Tactical asset
allocation
Strategic asset
allocation
Portfolio weightings
ESG profile (vs.
benchmark)
Value-at-risk
analysis
ESG and financial risk
exposures and limits
Portfolio scenario
analysis
Research level
Security level
Porfolio level
RE
SE
A
R
C
H

Guidance and Case studies for ESG Integration: Equities and Fixed Income
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6
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
 
■
Company questionnaires: Questionnaires sent to companies to collect more ESG 
data and information where the company’s level of public ESG disclosure is inad-
equate. These questionnaires are also used in parallel with regular company meet-
ings, 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 concur-
rently 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 meet-
ings. Committees meet to discuss ESG strategy, ESG performance of portfolios, 
and/or controversial securities.

The ESG Integration Framework
7
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
Active Ownership
 
■
Voting: This structured process captures all voting rights and applies a rigorous 
analysis to management and shareholder resolutions before casting votes. In addi-
tion 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 struc-
tured 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., rev-
enue, 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 (sensi-
tivity analysis) and different ESG scenarios (scenario analysis) are applied to valu-
ation 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.

Guidance and Case studies for ESG Integration: Equities and Fixed Income
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8
 
■
Relative value analysis/spread analysis: An issuer’s ESG bond spreads and its rel-
ative 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 analy-
sis) and different ESG scenarios (scenario analysis) are applied to valuation mod-
els 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 finan-
cial 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.

9
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
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 finan-
cial 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.

Guidance and Case studies for ESG Integration: Equities and Fixed Income
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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 informa-
tion 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.

ESG Integration Overview
11
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
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 miti-
gate or outweigh the ESG risk associated with its sector; or
o a company’s strong environmental and social management and good gover-
nance 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 inte-
grating 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” deci-
sion. For example, if a company or country is viewed poorly based on its ESG per-
formance 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.

Guidance and Case studies for ESG Integration: Equities and Fixed Income
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12
 
■
The ESG analysis can be the deciding factor between otherwise identical compa-
nies 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 outper-
form 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, valuation-
model 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, valuation-
model 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 prac-
titioner 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, envi-
ronmental issues, and social issues into their equity analysis, compared to the percentage 
1 CFA Institute and Principles for Responsible Investment (PRI) commissioned the firm YouGov to adminis-
ter 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.

ESG Integration Overview
13
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
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 strat-
egies. ESG integration in equities started gaining momentum at the beginning of the 21st cen-
tury, 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 argu-
ments 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 incorpo-
rate ESG issues into fixed-income portfolios and funds. Of course, fixed-income practitio-
ners 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 
2 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
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%

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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 cred-
itworthiness. 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 respon-
dents believe that ESG issues are impacting share prices, corporate bond prices, and sover-
eign 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
ESG ISSUES IMPACT ON SHARE PRICES 
Governance
58%
65%
Environmental
23%
52%
Social
23%
46%
ESG ISSUES IMPACT ON CORPORATE BOND YIELDS/SPREADS
Governance
41%
53%
Environmental
15%
40%
Social
15%
35%
ESG ISSUES IMPACT ON SOVEREIGN DEBT YIELDS
Governance
35%
44%
Environmental
12%
31%
Social
18%
32%
Note: Percentages represent respondents who answered “often” or “always.”

ESG Integration Overview
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© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
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 knowl-
edge, 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 mar-
ket. 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 sug-
gest 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 fre-
quently 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 envi-
ronmental 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 propri-
etary scores and their accompanying analysis to assess the potential impact of ESG issues 
on corporate performance and investment performance of companies and sectors.

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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 correla-
tions 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 fac-
tors 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 indi-
cate 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 fac-
tors 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 adjust-
ments 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.

ESG Integration Overview
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© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
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 com-
pany, but it is difficult to price it into the company’s valuation. One approach used by prac-
titioners 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 com-
panies 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 funda-
mentals, 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

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by a company could be investible while the company’s long-dated bonds may not be, if the 
practitioner perceives that the ESG risk will not materialize within the next five years. 
Corporate Credit Analysis
That the order of the frequency of impact of environmental, social, and governance issues 
on corporate bond prices and share prices is the same is not surprising. The material ESG 
issues for a company remain the same regardless of whether the investor is a shareholder 
or a bondholder. For example, health and safety remains a top ESG issue for mining com-
panies and their owners and lenders (see Figure 1 for examples of ESG issues analyzed by 
equity and corporate bond investors).
This is reflected in the approach used by some practitioners. Materiality/sustainability 
frameworks—a regularly reviewed list of sector-specific and/or country-specific ESG issues—
are shared by corporate fixed-income practitioners and equity practitioners to identify material 
ESG issues. In instances where asset owners and investment managers deploy dedicated ESG 
teams, fixed-income and equity practitioners share this resource and use the same company 
ESG research. Other practitioners will adapt the materiality/sustainability frameworks used by 
equity teams where material issues can be different for corporate bond issuers (e.g., innovation 
management may be less relevant), especially when considering the duration of bonds.
Practitioners use materiality/sustainability frameworks and company ESG research in 
their credit risk analysis. Few practitioners have looked at the impact of ESG issues on 
interest rate risk, yield curve risk, and liquidity risk. 
Practitioners assess the impact of ESG issues on a company’s ability to pay its debt obli-
gations and liabilities. Their main approach is to use third-party ESG scores or proprietary 
ESG scores along with traditional credit analysis when making investment decisions. Some 
practitioners embed their company ESG research and scores into their internal credit 
assessments. When they do so, the ESG issues can influence credit assessments and invest-
ment decisions.
FIGURE 1:  EXAMPLES OF ESG ISSUES ANALYZED BY EQUITY INVESTORS AND CORPORATE 
BOND INVESTORS
GOVERNANCE ISSUES
SOCIAL ISSUES
ENVIRONMENTAL ISSUES
Business integrity
Shareholder rights
Executive pay
Audit practices
Board independence and expertise
Fiduciary duty
Transparency/accountability
Related-party transactions
Dual-class share structures
Tax practices
Human rights
Employee relations
Skilled labor
Health and safety
Diversity
Customer relations
Product responsibility
Climate change
Biodiversity 
Energy resources and 
management
Biocapacity and ecosystem 
quality
Air pollution
Natural resources
Water resources and pollution

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© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
On a lesser scale, the impact of ESG issues is being quantified by practitioners in port-
folio construction processes and fundamental credit analysis. Portfolio construction tools 
would examine how ESG issues are influencing macroeconomic and market factors. The 
impact on the portfolio is through the weighting of sectors and companies. 
Through fundamental credit analysis, key credit ratios are adjusted for ESG issues. 
Practitioners assess these ratios to understand whether the creditworthiness of the com-
pany is deteriorating or improving and ultimately, to see the potential impact on credit 
ratings and credit spreads.
Sovereign Credit Analysis
As compared to their use with corporate bonds, ESG integration practices in sovereign 
debt are less widespread. 
The current low adoption of ESG integration by sovereign-debt practitioners is due 
in part to the lack of understanding of how to integrate ESG issues into sovereign debt. 
Unlike some corporate bond practitioners, sovereign-debt practitioners are not able to sim-
ply borrow techniques and materiality/sustainability frameworks from their fellow equity 
practitioners, which might speed up the integration process. Extensions to existing frame-
works or additional frameworks drawn up for country-specific factors are likely needed. 
The lack of understanding may be exacerbated by the difficulties expressed by prac-
titioners with sourcing ESG data on countries as compared to sourcing company data, 
especially environmental data (see Figure 2 for sources of ESG data used by sovereign debt 
investors). This makes it more difficult for practitioners to assess the absolute and relative 
FIGURE 2: EXAMPLES OF ESG DATA SOURCES FOR SOVEREIGN CREDIT ANALYSIS
Freedom House—Freedom in the World survey
Reporters without Borders—World Press Freedom Index
Forum for a new World Governance—Worldwide Governance Index
Bündnis Entwicklung Hilft—The World Risk Index 
Transparency International—Corruption Perceptions Index
World Bank—Ease of Doing Business Index
United Nations Development Program—Human Development Index
Fund for Peace—Fragile State Index
Organisation for Economic Co-operation and Development—Better Life Index
International Labour Organization—labor and health and safety statistics
Access Initiative and World Resources Institute—Environmental Democracy Index
Natural Resource Governance Institute—Resource Governance Index
Yale University—Environmental Performance Index
World Energy Council—Energy Trilemma Index
International Monetary Fund—country reports
EU—country reports
US Central Intelligence Agency—World Factbook
ESG research providers
Credit rating agencies

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ESG performance of a country and in turn, convert the ESG data/analysis into meaningful 
indicators to support their ESG integration practices. 
Another reason for the lower usage of ESG in sovereign credit analysis relates to the 
CFA-PRI survey finding that suggests that ESG issues are less material for sovereign debt 
compared to their impact on shares and corporate bonds (see Table 2). Practitioners may 
believe that ESG issues do not impact sovereign debt prices and therefore ESG integration 
is not applicable. However, the CFA-PRI survey did indicate that governance issues, social 
issues, and environmental issues are impacting prices (see Figure 3 for examples of ESG 
issues analyzed by sovereign debt investors). 
As highlighted earlier, the respondents believe that social issues more frequently affect 
sovereign debt prices than environmental issues (see Table 2). Practitioners are more likely 
to analyze social information on a country than environmental information, especially as 
the time scale of social issues is more aligned with the investment horizon for sovereign 
debt. The more-readily available social data also makes it easier for practitioners to inte-
grate social issues into their sovereign credit analysis.
Despite these challenges, practitioners are integrating ESG issues into their sovereign 
credit analysis. The majority are making qualitative assessments of ESG issues through the 
use of third-party research and/or internal research; these assessments then inform their 
investment decisions. Quantifying ESG issues in sovereign credit analysis is not widespread 
and is practiced less than when performed with corporate credit analysis. It tends to be 
performed by feeding ESG research and/or scores into the credit analysis of an issuer, 
which can cause adjustments to credit ratings or internal credit assessments.
Another common approach to sovereign credit analysis is to analyze ESG issues 
through portfolio construction tools. ESG issues can then influence allocations to regions 
and countries, providing underweight, neutral, and overweight signals. 
As well as analyzing the impact of ESG on a country’s ability to pay its debt obligations, 
practitioners have used ESG information to assess a country’s willingness to pay its debt 
obligation. For example, an investment manager who believes a link is present between a 
FIGURE 3: EXAMPLES OF ESG ISSUES ANALYZED BY SOVEREIGN DEBT INVESTORS
GOVERNANCE ISSUES
SOCIAL ISSUES
ENVIRONMENTAL ISSUES
Institutional strength
Corruption
Regime stability
Rule of law
Security
Regulatory effectiveness and 
quality
Accounting standards
Freedom of the press
Political and civil liberties
Human rights
Education and human capital
Health levels
Political freedoms
Demographic change
Employment levels
Life expectancy
Social exclusion and poverty/
income disparity
Trust in society/institutions
Crime and safety
Food security
Effects of climate change
Water resources and pollution
Biodiversity 
Energy resources and 
management
Biocapacity and ecosystem quality
Air pollution
Natural disasters
Natural resources

ESG Integration Overview
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© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
country’s level of corruption and its willingness to pay might use that link as justification 
to adjust country credit ratings and outlooks that they believe do not reflect the level of 
corruption in those countries.
Municipal Credit Analysis
ESG Integration Practices
The sub-sovereign bond market is composed of any level of government below the national 
or central government. This includes relevant bodies from regions, provinces, states, or 
municipalities that issue bonds. The US sub-sovereign market consists of mainly munipical 
bonds. At approximately $3.85 trillion in size, the US municipal bond market represents 
most of the global municipal bond market.3 
ESG factors have long been used to determine a bond’s credit quality in the municipal 
space and to identify financial risks in a municipality’s operations or for a particular pub-
lic project. The quality of the issuer’s governance and management practices are typically 
a constant in credit analysis for any municipal bond issuer. Practitioners look at overall 
transparency and reporting, corruption levels, sound budgetary practices, and responsible 
use of debt (e.g., close monitoring of long-term pension liabilities and principal maturities, 
implementation of affordable capital plans, strong financial controls). They might view a 
management team that provides robust disclosure in a positive light relative to its peers. 
Sound governance can also be assessed for those issuers who think beyond immediate 
budgetary needs and make investments intended to strengthen the economic success and 
social inclusiveness of their communities, as inclusive communities should exhibit stronger 
creditworthiness and lower risk for practitioners. As such, municipal borrowings that pro-
vide social benefits may offset the negative impact of temporarily weak finances. 
For both general obligation and revenue bonds, chronic social and environmen-
tal problems can affect the issuer’s ability to raise revenues from taxes or other types of 
income. For example, low high school graduation rates, high violent crime rates, lack of 
affordable housing stock in the community, and high unemployment rates could result in 
long-term credit stress. Environmental factors such as the region’s air quality and associ-
ated health risks for its constituents, the quality of public infrastructure such as wastewater 
treatment plants, or the long-term impact of climate change can all pose potential risks to 
macro factors that may affect an issuer’s ability to repay its debt. Overall, some practitio-
ners find that the more a municipality’s purpose or public project aligns with the environ-
mental and social needs of its constituents, the more likely it is that it will repay the bond. 
For project revenue bonds, practitioners may also integrate additional ESG factors based 
on the underlying use of the proceeds (e.g., giving more weight to environmental factors for 
electric and water utilities, to social factors for education, and to healthcare issuers). 
Because of the limited coverage of this asset class by third-party research providers, 
practitioners often use discretion to determine materiality and integrate ESG factors 
through the fundamental research process. Practitioners in the municipal market may 
3 SIFMA US Quarterly Highlights 1Q ’18, April 2018. https://www.sifma.org/wp-content/uploads/2018/04/
US-Quarterly-Highlights-2018Q1-2018-04-06-SIFMA.pdf

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depend more strongly on credit ratings agency research, and may integrate ESG factors by 
expanding their view to include environmental indicators that capture local and regional 
resource challenges.
Structured Credit Analysis
ESG Integration Practices
In addition to bonds issued by governments and companies, the fixed-income market 
includes securities backed, or collateralized, by a pool of financial assets, such as mort-
gages, accounts receivable, or automobile loans. Practitioners are just starting to consider 
how to systematically integrate ESG factors into structured credit analysis, largely because 
ESG data coverage is less readily available for some of the transaction parties, including 
the special purpose vehicles that issue the securities, and the inherent complexity of assess-
ing underlying asset pools that may run into the thousands. 
The integration process typically seeks to capture risks at several levels: at the transac-
tion level, relating to the originator/ servicer/issuer of the securities; at the “collateral” 
or “cover” pool of underlying assets; and sometimes, informing a view on the overall deal 
structure. Some practitioners give more weight to the originator, others to the credit qual-
ity of the underlying asset pool. The approach varies for different types of securitized 
investments depending on whether the issue is government backed, and with respect to 
the overall composition/asset concentration levels of the loan portfolio. 
At the transaction level, ESG analysis plays an important role in determining the true 
risk-adjusted credit profile of a securitization through an understanding of the corporate 
governance strategy of each of the parties associated with the deal. For example, practi-
tioners may review the lending practices of the financial institutions that are originating 
the securitization, prioritizing those with clearly stated guidelines for underwriting and a 
positive record of servicing loans, and avoiding those with predatory practices, poor risk 
management and regulatory compliance track records, and any conduct failings that could 
lead to litigation risks and other adverse consequences for loan enforceability. 
Strong governance practices cover transparency of management (e.g., publicly listed 
companies with audited, detailed financial statement disclosures, whose management team 
communicates regularly with investors), executive compensation, and board independence 
(e.g., a diverse board with appropriate controls). Practitioners may also evaluate whether 
the parties are using securitization as a method of exit or risk transfer, or as a funding 
source in which they will continue to participate.
At the asset pool, or collateral, level, practitioners consider how ESG factors may affect 
the financial sustainability of the asset pools, such as auto loans and mortgages.4 Although 
the analysis can differ between different asset pools, the objective remains the same—to 
understand if any ESG risks exist that would inhibit the asset pool from performing as 
expected, and to accurately value those risks. 
4 PRI 2014, Fixed Income Investor Guide. https://www.unpri.org/fixed-income/fixed-income-investor-
guide/30.article

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Depending on the nature of the collateral, ESG analysis may be given more focus. 
Consider these examples:
 
■
When analyzing securities backed by power assets or power contracts, practitio-
ners may focus on the environmental risk profile of the underlying assets (e.g., the 
source of power generation). 
 
■
When analyzing securities backed by commercial or residential properties, prac-
titioners may consider environmental factors on either a specific property or a 
corporate level, given the increasing impact of environmental regulation faced by 
property owners in some markets. As such, practitioners can analyze the energy 
efficiency of a property portfolio in relation to standards such as the UK’s Energy 
Performance Certificate (EPC) or the US Leadership in Energy & Environmental 
Design (LEED) certification program.
 
■
When analyzing securities backed by auto loans, environmental and gover-
nance failings such as the 2015 automotive sector emissions testing deception 
are assessed as a material risk to the value of the automobiles in auto loan/lease 
securitizations.
 
■
When analyzing securities backed by general consumer/credit card loans, practi-
tioners tend to consider societal risks, such as discriminatory and predatory lend-
ing and aggressive and deceptive marketing practices, as material factors.
Quantifying ESG issues in structured credit analysis is limited to the extent that it 
helps identify securities with mispriced prepayment assumptions, which may trade at a dis-
count relative to intrinsic value. For example, servicers that aggressively target borrowers 
for refinances or servicers that have streamlined procedures for refinances may be avoided, 
or valued less when bonds are trading at a premium. Qualitative analysis focusing on con-
ducting thorough due diligence of parties to the transaction may ensure no red flags are 
present among those associated with deals, while looking through the underlying assets 
may assist with monitoring the performance of the deal for as long as the practitioner is 
invested in the security. 
Many of the practices mentioned in this section are demonstrated by analysts, portfo-
lio managers, and investors, who share how they integrate ESG into their analysis and to 
tell their stories of ESG integration.

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EQUITY CASE STUDIES

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26
AGF INVESTMENTS INC.
EVALUATING ESG IMPACT ON  
REVENUE AND MARGINS
Hyewon Kong, CFA 
Environmental, social, and governance (ESG) factors are incorporated on a top-down 
basis by looking at macro trends to identify investment risks or opportunities. Our process 
seeks to identify companies aligned with ESG macro themes: energy and power technolo-
gies, waste management and pollution control, water and wastewater solutions, and health 
and well-being. As the world transitions to a more sustainable economy, investing in these 
themes positions the portfolio to benefit from these long-term trends, which provide long-
term secular growth. 
BOTTOM-UP INTEGRATION
Our bottom-up fundamental analysis incorporates ESG factors in our security selec-
tion process that are material to long-term financial performance. ESG analysis is not 
conducted by segregated ESG analysts but performed by our investment team members 
(including portfolio managers and analysts), who examine ESG considerations for the 
companies they cover. We adjust the most relevant financial forecasts (revenue, profits/
returns on capital, capital and operational expenditures, and cash flows) based on mate-
rial ESG factors. We also consider the potential ESG impact on the overall security valua-
tion by adjusting the target multiples (discount/premium, discount rate). 
PORTFOLIO COMPANY: COMPANY A 
Company A is one of the world’s leading suppliers of specialty chemicals based on renew-
able raw materials that are used in personal care, life sciences, performance technologies, 
and industrial chemicals. Company A enjoys an industry-leading position in sustainabil-
ity, having differentiated itself from its petrochemical-based specialty chemical peers.  
Two-thirds of Company A’s raw materials come from natural sources, and 94% of the com-
pany’s sustainable products—those expected to be top-50 sellers over the next five years—
offer a known sustainability benefit in use. 
Company A is well positioned to participate in this transition, as its growth drivers are 
directly influenced by global megatrends, including:
■
■
aging populations that will require more health and well-being products;
■
■
regulations that influence a move toward biodegradable/bio-derived plastics;

Evaluating ESG Impact on Revenue and Margins 
27
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
 
■
evolving consumer sensitivity to “green” issues, including sustainability—having 
“100% renewable” energy and product sources is likely to become an increasingly 
important differentiator; and 
 
■
disposable income growth in emerging economies that will increase the demand 
for greater crop protection and yield enhancements (crop care was 15% of 
Company A’s 2017 earnings before interest and taxes [EBIT]). 
INNOVATION-DRIVEN BUSINESS MODEL
Company A develops innovative ingredients with intrinsic and extrinsic sustainability ben-
efits. The company monetizes on its innovation-driven and protected product portfolio 
(see Figure 1). 
Through continuous innovation and products heavily protected via a network of pat-
ents, Company A has established itself in a leading position in terms of both relative mar-
gins and returns. Technology and innovation provide a strong moat in the form of high 
barriers to entry and close customer relationships, enabling strong pricing power and supe-
rior EBIT margins for Company A compared with its chemical-sector peers (see Figure 2). 
In line with its history of innovation, Company A opened an in-house bio-based eth-
ylene oxide (EO) plant in 2017. Surfactants are traditionally produced from the fossil 
fuel–based petrochemical ethylene. The feedstock for the new plant is bioethanol, and 
Company A will produce first-of-its-kind bio-based surfactants, replacing 21 kilotons of 
synthetic EO capacity. 
FINANCIAL IMPACTS 
 
■
Revenues: The plant will allow Company A to capture more of the value chain in 
surfactants (replacing bought-in petrochemical-derived EO) and enable Company 
A to charge a premium as consumers are willing to pay more for sustainable 
products. This will improve revenue growth through increased share and pricing 
FIGURE 1: SALES GROWTH AS A PERCENT OF GROUP SALES IN NEW AND 
PROTECTED PRODUCTS
2012
£216m
20.5%
+75%
£379m
27.6%
2017
Source: Croda Capital Markets Presentation, April 2018.

Guidance and Case studies for ESG Integration: Equities and Fixed Income
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28
growth by converting existing product sales to 100% renewable, 100% bio-based 
new product line, which will be tested and certified to the BioPreferred® Program 
by the US Department of Agriculture.
 
■
Operational costs: Company A will be able to reduce its operating costs through 
improved management and a decrease in the need to manage the logistics of haz-
ardous materials such as petrochemical ethylene. 
Our valuation assumes that Company A’s latest innovation in biosurfactants can posi-
tively contribute to both revenue and profit growth. Our base-case scenario assumes no 
volume benefit but a 2% price increase (a “premium” for sustainable surfactants by upgrad-
ing the existing product sales to the new product line certified to the USDA BioPreferred®
Program). This can contribute 30 basis points (bps) to the group’s top-line for the next 
five years and a 100-bps benefit to EBIT from cost savings (including transport logistics, 
because the need for costly shipping of EO materials is eliminated due to the shift to in-
house bio-based EO) (Figure 3).
Company A trades at a discount to the average multiple for consumer chemical stocks 
given its recent muted organic growth. Following its innovation and new products develop-
ments, we believe Company A can return to a long-term 4%-plus organic growth rate (with 
the contribution from bio-based EO) and pricing growth, which will help Company A’s 
target multiples to be re-rated. Our discounted cash flow model implies an upside of 14% 
with a value of £56.34 per share, based on a weighted average cost of capital of 6.2%.
FIGURE 2: COMPANY A’S OPERATING MARGIN VERSUS CHEMICAL-SECTOR PEERS
0.00
5.00
10.00
15.00
20.00
25.00
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
Operating Margin %
Company A
Company B
Company C
Company D
Company E
Peer Average
Source: Bloomberg, as of 31 December 2017.

Evaluating ESG Impact on Revenue and Margins 
29
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
FIGURE 3: EBIT UPLIFT FROM THE INTRODUCTION OF SUSTAINABLY 
SOURCED ETHYLENE OXIDE
US PERSONAL CARE SALES
15%
Volumes 
+0%
Price 
+200 bps
INCREMENTAL ORGANIC GROWTH
+200 bps
CONTRIBUTION TO GROUP ORGANIC GROWTH
+30 bps
Cost of goods sold savings
£4 m
EBIT 
+100 bps
Source: AGF Investments Inc., as of 30 June 2018.

WWW.CFAINSTITUTE.ORG
30
ALLIANCEBERNSTEIN L.P.
ESG INTEGRATION IN ACTION: 
APOLLO HOSPITALS 
Edward Bryan
AllianceBernstein’s Sustainable Global Thematic team assesses investment candidates 
based on the spread between the return potential given a five-year holding period and an 
estimated cost of equity (COE) hurdle rate. This hurdle rate considers a bottom-up, fun-
damental risk analysis, which also incorporates each company’s key environmental, social, 
and governance (ESG) issues (Figure 1). 
Apollo Hospitals Enterprise Limited operates the largest chain of private hospitals 
and pharmacies in India. Over the years, Apollo has built one of the most trusted health-
care brands in a country whose healthcare infrastructure is far below the World Health 
Organization’s recommendations for hospital beds per person. Apollo recently expanded its 
inventory of hospital beds to meet local demand, straining its balance sheet and profitability. 
During our on-the-ground due diligence of Apollo’s operations, we learned more 
about innovations such as a “hub and spoke” approach to serving local markets and a tele-
medicine command center that enables rural clinics to access treatment and procedure 
advice from doctors in larger cities. We also saw firsthand the promising strategic position 
of its hospitals within cities. 
These findings gave us confidence that Apollo’s profitability is poised to rebound as 
patient occupancy in new hospitals improves. We believe the company has a long runway of 
FIGURE 1: ALLIANCEBERNSTEIN’S INVESTMENT FRAMEWORK ILLUSTRATIVE EXAMPLE
UN SDG 
Market 
Opportunities
Interim 
Cash Flows
T+5 Profits/
Book Value
Terminal 
Multiple
IRR
COE
IRR—COE Spread /  
Degree of Relative Attractiveness
Geography-Specific 
Risk-Free Rate
Premortem Risk
Equity Risk Premium
ESG Risk 
Scores
+
X
X
X
Abbreviations: COE, cost of equity; IRR, internal rate of return; UN SDG, United Nations Sustainable 
Development Goals.

ESG Integration in Action: Apollo Hospitals  
31
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
potential revenue and earnings growth as well as reinvestment opportunities as it addresses 
India’s need for more modern medical facilities. Beyond the recent expansion of hospital 
beds, future investment areas include diagnostic labs, pharmacies, and smaller clinics in 
smaller cities to further improve access to care in India and generate referrals for Apollo’s 
larger hospitals. 
Also, our grassroots meeting with consumers highlighted better access to infrastruc-
ture and awareness of health issues through the adoption of smartphones—these are 
underappreciated drivers of demand for modern medical services.
These insights make us confident in our attractive outer-year growth forecasts and ter-
minal value calculation, which are major drivers of our company valuation models. We cal-
culate a bottom-up internal rate of return (IRR) for the company, which approximates the 
return potential for owners of the business. IRRs are calculated using the current share 
price, cash flow over the next five years, and a terminal value for the business, discounted 
back to today.
The typical focus in IRR calculations is on financial projections over the next few 
quarters. We seek to generate the most differentiated views relative to consensus by leverag-
ing our insights for growth potential over a multiyear period, which we believe is necessary 
in understanding the potential of a long-term theme such as healthcare improvements in 
India. Our insights are informed by analysis of products and services that stand to benefit 
from or help in the application of the United Nations’ Sustainable Development Goals (a 
collection of 17 global goals set in 2015). 
We compare our IRR estimate to a bottom-up, forward-looking COE hurdle rate to 
determine how attractive the investment is on a relative basis. Our COE scores are the 
function of a risk-free rate, adjusted for the geographical breakdown of each business, and 
a 6% equity-market risk premium. This is adjusted by a forward-looking beta based on the 
aggregate of what we see as the company’s top-10 risks—this must include a specific score 
for ESG issues and controversies. 
We derive the top-10 individual risks from a “premortem” exercise. We imagine that 
the stock has already been a disappointment and we ask why that might be. We give each 
risk a score ranging from 1 to 10, representing the financial impact and likelihood of the 
risk playing out over our investment time horizon. 
One example of a top-10 individual risk is recruitment and retention. In Apollo’s case, 
given the relative shortage of medical personnel, maintaining a staff of well-trained doc-
tors is a high priority (particularly during its recent expansion phase) and a key social risk.
To properly assess key issues such as recruitment and retention, we believe that it is 
critical to engage directly with company management. We learned about recent changes to 
Apollo’s remuneration policy for doctors, including the extension of guaranteed salaries 
for the first year of a new hospital’s operation. According to Apollo, this helps attract medi-
cal talent in the first year or two as patient volumes increase. After that period, doctors can 
rely on the traditional “fee for service” salary model for competitive compensation.
Apollo estimates its doctor attrition rate at about 2%, which it sees as being lower than 
other hospitals in India. However, the company faces more acute retention issues among 
nurses, where employee turnover is above 30%. According to Apollo, nurses view the com-
pany’s operations as an attractive system for training but are then lured overseas by higher 
salaries. Although these nurses eventually return to India, Apollo recognizes the impact

Guidance and Case studies for ESG Integration: Equities and Fixed Income
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32
the turnover rate has on productivity and has hired a consultant to develop new recruiting 
and retention tools and incentives to address this turnover issue.
Key risks such as staffing—and Apollo’s strategies to address them—are direct inputs 
into our COE hurdle rate. Without engaging with Apollo management, the analysis would 
be less granular—and the inputs less informed. Employee retention is still a high-impact 
risk for Apollo, but a strong brand and efforts to retain and attract employees are offset-
ting factors that reduce this social-risk score in our premortem analysis. We adjust the 
inputs dynamically based on the success of Apollo’s strategies or lack thereof.
A company’s efforts to reduce risk are factored into the premortem analysis. Lower 
risk scores can make companies appear more attractive—in the same way that higher rev-
enue and profit growth would improve the IRR. The swing from high to low premortem 
risk scores can mean the difference between an unattractive investment candidate and one 
for which the return potential compensates for the risk.

33
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
ARISAIG PARTNERS 
DEVELOPMENT OF A BROADER ESG 
STRATEGY FOR GODREJ GROUP: ARISAIG 
PARTNERS’ APPROACH TO ESG CRITERIA 
Amitoj Saini
Founded in 1996, Arisaig Partners is a boutique investment management firm that invests 
in what we believe are the best emerging-market consumer business. We run concentrated 
portfolios in our Asia, Africa, Latin America, and Global portfolios, and our buy-and-hold 
investment approach is very long term—we value our businesses using a 20-year view. We 
see ourselves as partners of both our portfolio holdings and our clients. Our long-term 
investment horizon means that understanding how environmental, social, and governance 
(ESG) factors contribute to investment performance is integral to our approach.
Our ESG approach is organized across three pillars: Understand, Integrate, and 
Engage (Figure 1). 
Our ESG assessment directly feeds into our valuation models, as we incorporate a 
“fade factor” into our forecasts, which is an additional discount rate that we apply to the 
terminal value of a company. The “fade factor” incorporates the impact that factors such 
as ESG have on the sustainability of a company’s economic moat over the long term; it 
is based on the assumption that despite the long heritage and strong brands of our con-
sumer franchises, the durability of their competitive advantage will diminish over time. 
The “fade factor” will be lower for companies with good ESG practices, strong manage-
ment, and sustainable moats. Retailers, for example, which are traditionally more prone to 
disruption, will have a higher “fade factor” as compared to branded consumer companies.
GODREJ CONSUMER PRODUCTS LIMITED
An example of our approach to ESG has been our analysis of and engagement with Godrej 
Consumer Products Limited (GCPL). GCPL is the largest listed company within the Godrej 
Group, one of the largest and oldest conglomerates in India with a significant presence in 
the areas of manufacturing, real estate, and the consumer segments. GCPL is India’s larg-
est household insecticides and hair color company and the second-largest soaps company. 
In addition to its markets in India, GCPL has an international business—with a presence 
in Indonesia, Africa, and Latin America—that accounts for almost half of its revenues. 
ARISAIG’S ENGAGEMENT WITH GCPL
Arisaig Partners has been an investor in GCPL since the company first listed in 2001, and 
we have met with its management about 150 times over the last 17 years. During this time,

Guidance and Case studies for ESG Integration: Equities and Fixed Income
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34
we have collaborated with GCPL’s management in several areas, from strategic discussions 
to developments on the ESG front. On the governance front, we have provided introduc-
tions to potential female corporate board members from our network in Africa. 
GODREJ’S GOOD & GREEN PROGRAM
Even at a relatively early stage of Godrej’s maturity, as an investor, we found that the Godrej 
family was managing the business with long-term value creation for both the business 
and broader society in mind. Launched in 2011, the Good & Green program formalized 
Godrej’s many initiatives into a broader strategy, with targets to 2020. 
These targets include the following: 
1. Ensure employability, with a goal to train one million rural and urban youths in 
skills that enhance their earning potential through employability projects.
2. Create a greener India, with a goal to achieve a zero landfill waste, carbon neutral-
ity, a positive water balance, a 30% reduction in specific energy consumption, and 
an increased use of renewable energy sources through the Greener India projects.
3. Innovate for good and green products, with a goal to have a third of Godrej’s port-
folio revenues composed of good and/or green products and services—defined as 
products that are environmentally superior or that address a critical social issue 
(e.g., health, sanitation, disease prevention) for consumers at the bottom of the 
income pyramid.
FIGURE 1: THE THREE PILLARS OF ARISAIG’S ESG INVESTMENT APPROACH
We undertake research
in order to develop a
broad view of the
evolving sustainability
landscape that companies
face. By focusing on the
most material issues for
our holdings, our ambition
is to understand the potential
impact of these issues
on investment returns.
Understand
Integrate
Engage
All of our ESG
assessments are
undertaken by the
analysts covering the
stocks and this
information is captured
in our central modeling
systems. Following the
assessment of a company
across the complete range of
ESG areas, we then identify
the most material issues
for that particular business.
Our ESG approach is
engagement focused.
We do not exclude
companies based on
ESG issues and would
rather work with
companies to help them
improve their ESG
performance. We
discuss ESG issues with our
holdings on a regular basis.
The objective of our
engagement is not only
to garner information to
inform our investment
analysis but also to encourage
behavior change.
Source: Arisaig Partners.
© 2018 Arisaig Partners. All rights reserved.

Development of a Broader ESG Strategy for Godrej Group: Arisaig Partners’ Approach to ESG Criteria 
35
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
The Good & Green program is set up at the group level, but corporate-level targets 
are set for each of the group’s subsidiaries. As a consumer business, GCPL has played a 
key role in achieving these objectives. GCPL runs the Salon-i program, which encourages 
more women to enter the work force and supports micro-entrepreneurs who are starting 
their own beauty salons. So far, over 150,000 women have been trained as part of this 
program. This is the most tangible example of the alignment of the social and economic 
missions of the company and its stakeholders.
TANGIBLE IMPACT
Our conversations with management over the last 17 years have been wide ranging, cover-
ing topics such as sustainable palm oil sourcing, governance setup, executive remunera-
tion, gender equality issues, and LGBTQ issues. We undertake site visits to meet staff at all 
levels of the organization and around the world. 
We have seen a significant improvement in GCPL’s investor engagement and corpo-
rate governance practices. Today, GCPL is one of the few companies in India where close 
to one-third of the company’s board representatives are women—a rarity in India. We see 
this as business-critical given that about three-quarters of consumer product purchasing 
decisions are made by women. 
There have been broader benefits from Godrej’s forward-thinking approach. We 
believe it has one of the strongest corporate cultures in our consumer universe, becom-
ing one of India’s foremost employers of choice—a hallmark previously attributed to only 
multinational companies (MNCs) in the fast-moving consumer goods (FMCG) space (e.g., 
Unilever or Procter & Gamble Co. in India). The ability to attract and retain talent has 
played an important role in improving the company’s operational performance. A direct 
impact has been on GCPL’s execution capabilities, as the company acquired businesses in 
new categories in India and expanded its presence in markets such as Indonesia, Africa, 
and Latin America. Our trust in GCPL management’s capabilities and the company’s solid 
corporate culture allowed us to provide steady support as the company evolved into an 
“MNC of the future.” 
These strengths have also had a material impact on our assessment of GCPL’s poten-
tial returns. Figure 2 illustrates how our estimated internal rate of return (IRR) for GCPL 
changes with different “fade factors.” Currently, we are applying a fade factor of 7.5% to 
the terminal value for GCPL, which gives us an estimated IRR of 9% for the company over 
the next 20 years.
FIGURE 2: APPLYING THE “FADE FACTOR” TO GCPL’S IRR
FADE FACTOR
0.0%
5.0%
7.5%
10.0%
GCPL IRR
12%
9.5%
8.5%
7.6%
Source: Arisaig Partners.
© 2018 Arisaig Partners. All rights reserved.

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36
FIGURE 3: PRICE-TO-EARNINGS VALUATIONS—GODREJ CONSUMER VERSUS HINDUSTAN 
UNILEVER
0.0
5.0
10.0
15.0
20.0
25.0
30.0
35.0
40.0
45.0
50.0
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
GCPL
Hindustan Unilever
Source: FactSet Research Systems Inc.
Looking through a different lens, there is little doubt that GCPL’s management profes-
sionalization and efforts such as the Good & Green program have played a key role in nar-
rowing the valuation gap with MNCs in India such that investors now view local champions 
like GCPL on a par with any MNC from an investment standpoint. As illustrated in Figure 3, 
GCPL’s 12-month rolling price-to-earnings valuations are now comparable with those of 
Hindustan Unilever (Unilever’s India subsidiary and India’s largest FMCG company). Over 
the period of our investment, GCPL has rewarded patient shareholders like us handsomely 
with a total shareholder return of 16% on an annualized basis.

37
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
AXA INVESTMENT MANAGERS ASIA (SINGAPORE) LTD.
A FRAMEWORK TO INCORPORATE 
SUSTAINABILITY “SUSTAINABLY” FOR 
QUANTITATIVE MANAGERS
Anubhuti Gupta, CFA, and Kathryn McDonald
The purpose of this case study is to show how Rosenberg Equities integrates sustainability 
holistically across all our quantitative equity strategies. We share a framework for any asset 
manager who desires to incorporate sustainability into the existing investment process. 
We believe that the process to integrate environmental, social, and governance (ESG) 
should begin with defining the motivation (the “why”)—the way any sound investment 
process begins. We believe you should define your ESG principles the way you would define 
your investment principles—they should be grounded in research and analysis and should 
have a link to measures that you believe drive risk and return in equities (see Figure 1).
The following are our ESG investment principles:
■
■
Companies that use their resources wisely should have an economic advantage 
over those that do not.
■
■
ESG information is economic in nature (independent of a values judgment) and 
complementary to traditional fundamentals (meaning it may change our opinion 
of the fundamental “worth” of a stock).
■
■
We see ESG information as complementary to the inputs we use to evaluate investment 
opportunities, in part because ESG generally represents long-horizon information. 
This belief is confirmed by our observation that ESG information is largely orthogonal 
to fundamental measures that we believe drive risk and return in equities.
■
■
We believe that ESG will help improve return and lower risk, over time and at the 
margin. We do not believe that ESG is a massive, untapped source of alpha, nor do 
we believe that ESG can help us avoid all low-probability/high-impact risk events. 
ESG is simply another lens that allows us to develop a more complete understand-
ing of the opportunities and risks faced by companies.
We arrived at these principles through our research, which gives us confidence that 
there is a link between ESG concepts and fundamental drivers of return and risk.
■
■
We show that companies with better governance exhibit higher quality and lower risk.
■
■
We show that carbon is being priced by equity investors. It behaves as an expense 
when modeled as an income statement item.
■
■
We show that corporate governance and attractive dividend profiles are well 
aligned, and we demonstrate that environmentally minded investors need not sac-
rifice their beliefs to achieve higher payout ratios.

Guidance and Case studies for ESG Integration: Equities and Fixed Income
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38
 
■
We show that diversity works as a “profitability moat” within the most profitable com-
panies, allowing them to better preserve their profitability by withstanding competi-
tive forces.
 
■
The ESG scores we use in portfolio construction add value to our investment 
decisions.
 
■
We are continuously expanding our research in this area to further refine our 
understanding and implementation of ESG insights into our investment process. 
Additionally, there is a long history of published literature and a growing body of 
research that supports the idea that ESG may be value-adding in both return and risk 
spaces. 
Having established the investment principles, the next step is to determine the 
framework for implementation (the “what”) based on your research process and data 
availability. Our ESG framework follows.
Our ESG scores are determined by our proprietary ESG Analysis Framework. To state 
the obvious, a system of comparable scores is needed for a quantitative process such as 
ours. We require significant data breadth for the ESG information to be actionable within 
our process—the system we have in place allows for excellent coverage in general. 
As of this writing, there is no market standard for ESG scoring, and no supplier is able 
to fully address all dimensions to our satisfaction. The quantitative scoring system we use 
within AXA Investment Managers seeks to build robust ESG scores by bringing together 
best-of-breed providers, applying qualitative expertise, and mitigating unintended biases. 
Our scores are based on data from multiple third-party vendors and qualitative expertise 
FIGURE 1: THE INVESTMENT PROCESS
Data Analysis
• 30 years of experience
• 40+ years of data
• 20,000 companies*
• Detailed financial data
• Nonfinancial data (e.g., ESG)
• Market prices
• Analyst views
• Proprietary adjustments
Stock Selection
Fundamental valuation
• Bottom-up valuation of assets and liabilities
• Account for delivered and  forecast earnings
• Assess fair value relative to price
Evolution of fundamentals
• Investor sentiment
• Earnings sustainability
Valuation context
Risk Analysis
ESG Considerations
Client  Guidelines
Trading Costs
Portfolio 
Construction
Client
Portfolio
Monitoring and Oversight
53 Investment Professionals
INTERGRATION AND VALIDATION
EXPECTED EXCESS RETURN (ALPHA)
Source: *Rosenberg Equities as of 31 March 2017. Rosenberg Equities reserves the right to modify any of the 
procedures, processes, and controls described herein at its discretion.

A Framework to Incorporate Sustainability “Sustainably” for Quantitative Managers
39
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
from sector specialists. The framework is built around three pillars: environment (E), 
social (S), and governance (G) criteria. Each pillar is then divided into factors and subfac-
tors to best address current trends and challenges facing today’s society. The scores are 
computed from the ground up, based on what we believe to be the best data items within 
each pillar, weighted according to what our team experts believe to be “material” informa-
tion for stocks in each sector and adjusted to remove regional/sector biases to suit our 
investment process. We believe this process captures the most comprehensive, holistic view 
of a company’s ESG threats and opportunities.
We have a strong preference NOT to apply divestment as a lever because the investment 
argument is mostly ambiguous. However, in some limited cases we have chosen to divest based 
on a unique investment case (such as tobacco companies, severe controversies, etc.).
We also model the carbon and water footprint of companies separately because these 
factors represent a risk to portfolios that is not adequately captured in traditional risk mea-
sures. Independent modeling offers us additional levers that we can use to adjust the car-
bon and water exposures of our portfolios. It also enables us to meet more bespoke client 
needs related to the carbon and water footprints of their portfolios.
Once you have clearly defined your ESG principles and established your ESG frame-
work, you need to determine the appropriate implementation model (the “how”) to inte-
grate ESG into your investment process. This model will depend on your investment 
style, the tools available to you, the degree of ESG conviction, and the diversity of invest-
ment strategies managed. 
For the purpose of this case study, we focused on how we integrate ESG into our 
Equity Alpha strategies. Our portfolio construction process for Equity Alpha strategies 
begins with the ranking of Rosenberg Equities’ proprietary fundamental valuation and 
earnings evaluation of all companies in our global investment universe (Figure 2). The 
riskiness of each stock is then calculated using a multifactor risk model. The risk and 
return assessments for each company in the investment universe are input to a Portfolio 
Construction Tool or Optimizer, along with several key parameters and constraints 
(such as exposures to industries, sectors, countries, and risk factors; stock position and 
active weight limits; client-specific restrictions; and trading costs). This is where the ESG 
integration is applied. 
 
■
Our objective is to maximize risk-adjusted return by building well-diversified port-
folios with superior fundamentals and modest active exposures to common risk 
factors and an improved ESG profile relative to the client’s chosen benchmark. 
 
■
We exclude the select companies and business lines we have chosen for divestment 
by restricting them from entering the optimization (again, these divestment cases 
are extremely limited). 
We provide the companies’ ESG scores, carbon and water scores, and ESG outcome 
key performance indicator (KPI) data as additional inputs to the portfolio construction 
module. The idea is to consider ESG outcome KPIs in an integrated fashion alongside 
return and risk considerations and other constraints. We define an additional expected 
utility term that is proportional to the company’s ESG score in the objective function.

Guidance and Case studies for ESG Integration: Equities and Fixed Income
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40
From an individual stock perspective, the following is an example of how ESG inte-
gration impacts the weights of stocks in our portfolios.
Figure 3 shows the composition of the India software and services sector for a model 
Asia (excluding Japan) Large Capitalization portfolio, with and without ESG integra-
tion. We can see that the active weights of companies are the outcomes of a balancing act 
between alpha scores, risk considerations, and ESG.
 
■
Tata Consultancy Services has a very high ESG score, but its alpha score is very low 
relative to its peers, so it is underweight in the ESG-integrated portfolio as well.
 
■
Larsen & Toubro and Mphasis Ltd. have similar ESG scores, which are lower than 
those of their peers. Larsen & Toubro has a much higher alpha score, so it receives 
as high an overweight allocation as it would in a non–ESG-integrated portfolio. 
Mphasis Ltd., on the other hand, receives a smaller overweight allocation because 
the alpha is not as high.
 
■
Wipro and Infosys have very high ESG scores, and the alpha scores are moderately 
high. Thus, they receive higher overweight allocations in the ESG-integrated port-
folio than they would in the absence of ESG integration.
Overall, the ESG-integrated portfolio has an improved ESG profile, while maintaining 
a similar risk profile and ex-ante risk-adjusted returns as the non–ESG-integrated portfolio.
In summary, we suggest that you carefully examine your beliefs about ESG and clearly 
document the investment motivation that forms the necessary “why” of any investment 
FIGURE 2: INTEGRATION OF ESG CONSIDERATIONS
Investment Universe
Quantitative Input
• AXA IM ESG model
• Trucost carbon and
water data
• Sustainalytics
controversy ratings
Qualitative Input
• Controversy review
• High-risk stocks/
industries
RI Screens
• APLMCB/palm oil 
• Tobacco
• NBIM
• Controversial stocks
ESG Optimization
• Maximize ESG score
• Minimize CO2 impact
• Minimize water intensity
ESG-Integrated Portfolio
with improved RI metrics and reduced exposure to ESG risks 
Screened Universe
Source: AXA IM. Exhibit created January 2018. AXA IM reserves the right to modify these processes at any 
time.

A Framework to Incorporate Sustainability “Sustainably” for Quantitative Managers
41
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
process. Once this has been established, the focus should turn to the “what”— the frame-
work for implementation. This should be very specific to a manager’s unique investment 
process and should focus on what is “actionable” with respect to attainable information 
and achievable implementation. Finally, documenting the effect of ESG integration on the 
portfolio is a critical final step. We have found that reporting based on both ESG scoring 
as well as specific KPIs that speak directly to client interest has been well received.
FIGURE 3: ESG INTEGRATION USING A MODEL ASIA (EXCLUDING JAPAN) LARGE 
CAPITALIZATION PORTFOLIO
-
2.00 
4.00 
6.00 
8.00 
10.00 
12.00 
14.00 
16.00 
(0.50%)
–
0.50%
1.00%
1.50%
2.00%
Infosys Ltd. 
HCL
Technologies 
Ltd.
Tech Mahindra 
Ltd.
Wipro Ltd. 
Larsen & Toubro 
Infotech Ltd. 
Mphasis Ltd.
Tata
Consultancy 
Services Ltd.
Active weight with ESG integration (left axis)
Active weight without  ESG integration (left axis)
ESG score (right axis)
Alpha score (right axis)
Source: Rosenberg Equities as of June 2018. The companies mentioned herein are for illustrative purposes 
only and do not constitute investment advice or recommendations.

WWW.CFAINSTITUTE.ORG
42
E FUND MANAGEMENT CO. LTD.
VALUATION ADJUSTMENT ACCORDING TO 
ENVIRONMENTAL REGULATIONS
Yixi Wei
In pursuit of long-term sustainable returns for our clients, E Fund Management Co., 
Limited incorporates environmental, social, and governance (ESG) factors into its invest-
ment research framework. In our investment philosophy, companies that perform well 
in ESG will benefit from enhanced long-term competitive advantages, reduced downside 
risks, and strengthened reputations. 
OUR UNDERSTANDING OF ENVIRONMENTAL,  
SOCIAL, AND GOVERNANCE FACTORS
We believe that good corporate governance allows for higher profits, lower expenses, and 
more innovation. It also reduces volatility by lowering financial risks and reducing financ-
ing costs. Companies adhering to sustainability development principles and outstanding 
environmental and social standards will more likely build up a positive brand image by 
providing high-quality products and services, which, in turn, will enhance client loyalty 
and employee motivation.
INTEGRATING ESG INTO OUR RESEARCH AND 
INVESTMENT PROCESS
Our ESG evaluation is conducted in parallel with fundamental analysis (Figure 1). When 
our portfolio managers make investment decisions, the ESG score is taken into account 
during the valuation adjustment. Therefore, a company’s ESG performance will be thor-
oughly considered in our investment decision. 
HOW WE ANALYZE SPECIFIC ESG ISSUES
On 11 November 2017, the Ministry of Ecology and Environment of China published 
“Regulations on a List of Key Pollution Entities.” These regulations emphasized four 
major types of pollution—water, land, air, and noise—each covering a variety of 
industries. 
Our ESG research team concluded that the government will enforce stringent pollu-
tion controls and decided to pay more attention to environmental risks in certain upstream

Valuation Adjustment According to Environmental Regulations
43
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
industries, such as the mining, metal smelting, and chemical industries. The following is a 
list of actions we took:
1. Developing an analysis framework: To analyze the environmental performance 
of companies, our ESG research team constructed a framework that consists of 
four factors, specifically focusing on environmental protection (these factors com-
prise one part of our ESG framework).
 
■
industry-related environmental risks and their impacts on the company
 
■
the company’s strategy in response to environmental risks and the quality of 
the company’s resource management
 
■
capital expenditure on environmental protection equipment and the effective-
ness of resource use
 
■
the company’s history regarding environmental issues, including negative 
news and violation records from local regulation departments
2. Rating and scoring environmental performance: Our analysts and portfolio 
managers use the framework as a guideline to evaluate companies. After in-depth 
research, analysts and portfolio managers rate each factor; a higher score means 
lower environmental risks and greater competitive advantages. By doing so, we 
convert the environmental performance to a quantitative score.
3. Valuation adjustments based on the environmental score: Our analysts and 
portfolio managers use environmental scores as references to guide valuation 
adjustments. Portfolio managers use the adjusted valuation to make investment 
decisions. The following are a few types of adjustment techniques.
 
■
adjusting target price to earnings (P/E), which reflects the company’s competi-
tiveness in comparison to its peers with higher/lower environmental standards
 
■
adjusting cost assumptions, which is related to future capital expenditures in 
environmental protection spending
 
■
adjusting required return rate or discount rate, which is influenced by the 
environmental risk premium.
FIGURE 1: ESG EVALUATION COMBINED WITH FUNDAMENTAL ANALYSIS
Investment 
Decision 
Based on 
F+ESG
Valuation 
Adjusted
Business Model
Fundamental Analysis
Valuation Model
ESG Score
ESG Risk Analysis
ESG
Framework/Evaluation

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4. Making better investment decisions: After implementing the ESG-integrated 
investment process, our portfolio managers can make better and more objective 
decisions. In our research and investment process, ESG analysis serves as an impor-
tant supplement to fundamental analysis. We believe that this process enables us 
to evaluate a company from a new perspective, one that is often ignored by most 
portfolio managers.
CASE EXAMPLE
Early this year, we conducted analyses on two companies (Y Chemical and H Corporation, 
both in the chemical industry sector) in the China A market. These two companies have 
similar business models and fundamental performances. 
Following our environmental framework, our analysts provided the following 
viewpoints:
 
■
Both Y Chemical and H Corporation have high levels of exposure to environmen-
tal risks. Environmental Risk Ratings for both Y Chemical and H Corporation 
were low.
 
■
According to onsite visit results, Y Chemical’s environmental management was 
slightly better than that of H Corporation’s. Y Chemical had its own sewage man-
agement system that was above the government-required standards. The Risk 
Response Rating was higher for Y Chemical as compared to H Corporation.
 
■
Y Chemical had consistently invested in various sewage and disposal projects; 
a good amount of investment was disclosed in annual reports since 2007. H 
Corporation disclosed cumulative capital expenditures in recent years without 
detailed information. The Capital Expenditure Rating was higher for Y Chemical 
compared to H Corporation.
 
■
Y Chemical had three negative news announcements in the last three years. H 
Corporation was fined four times by the local government for environmental vio-
lations and had two negative news announcements in the last three years. The 
Historical Record Rating was higher for Y Chemical compared to H Corporation.
We concluded that Y Chemical’s total score was 9, and H Corporation’s score was 5, 
indicating that Y Chemical has lower environmental risks as compared to H Corporation. 
No reliable method was available for us to estimate the projected environment protec-
tion cost, so our portfolio manager decided to adjust the target P/E to reflect our lower 
return expectation for H Corporation. Compared to the industry average—23.7 P/E (trail-
ing 12 months)—H Corporation was given a discounted target of 20 P/E by our portfolio 
manager, while maintaining the same estimation for other fundamental valuations. As a 
result, H Corporation was estimated to have a negative return in our valuation model and 
deemed not worth investing in. We considered H Corporation to be overpriced by the mar-
ket because the environmental risks were not fully considered.

45
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
EASTSPRING INVESTMENTS 
MITSUBISHI MOTORS CORPORATION
Michael Woolley
Eastspring Investments (Singapore) Limited Singapore-based Value Equity team focuses 
solely on exploiting significant price episodes, where changes to the market’s risk percep-
tions and expectations have caused a meaningful dislocation between the price and long-
term trend valuation of a company. 
First, we identify significantly mispriced opportunities based on long-term relative 
valuation. Our focused research helps us to understand the sources of market mispricing 
through deep fundamental analysis.
In addition to exploiting significant price episodes, we invest a significant amount of 
effort into conducting a thorough due diligence on both the financial and nonfinancial 
aspects of a company. In building our fundamental assumptions that underpin the 
valuation for a company, we apply a holistic approach to identifying material risks—
including environmental, social, and governance (ESG) issues—to the sustainable 
earnings of a company. We rely on the robustness of our proprietary fundamental research 
process and apply our judgment to assess material factors that impact sustainable earnings. 
We require significant valuation support to compensate for material risks to longer-term 
sustainable earnings.
ESG issues and their potential impact differ across companies and are only incorpo-
rated into our fundamental analysis and decision-making process when we believe they 
could have a material impact on a company’s valuation and financial performance. We 
have adopted tools that assist in the efficient identification of ESG issues related to the 
companies we research. We currently use the Sustainalytics ESG tool to assist in our deep 
due diligence, which includes preparation for company engagement.
As part of our due diligence, we test aspects that are material to a company’s ability to 
fund its longer-term operations: 
■
■
changes in its level of capital efficiency; 
■
■
its ability to focus on parts of the business that are core to the future drivers of 
profitability; 
■
■
the ability and willingness of management to respond in a competitive market 
environment; 
■
■
potential impacts from the quality of corporate governance; and 
■
■
the risks associated with environmental and social business performance that may 
impact its “social agency”—its ongoing franchise and the likely impact of manage-
ment’s behavior on longer-term returns. 
We test the sensitivity of our valuation to changes in our trend assumptions, which 
inform the level of confidence (or conviction) we may gain for the longer-term trend valu-
ation of a company.

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46
Implicit in our approach is that we do not screen out companies solely on the basis of 
perceived problematic ESG issues. Although this approach does not prohibit us from pur-
chasing or holding a position due to an ESG issue, consideration of these issues is made 
part of the investment decision.
Having identified potential risks to sustainable earnings, we may consider an invest-
ment where there is sufficient conviction in our fundamental assumptions and where we 
are more than compensated by valuation support.
A patient time frame can improve the probability of outcomes. We believe our focused, 
valuation-driven approach is clearly aligned with stewardship activities, including ongo-
ing company engagement, for shareholder value realization over the longer term. Our 
approach is aligned with promoting increased long-term value creation and sustainable 
business practices by companies. The approach focuses principally on long-term factors 
that determine companies’ earnings, rather than on the short-term factors that may pre-
dominate in determining share prices. We place a high level of importance on an ongoing 
dialogue with investee companies primarily based on what we believe will maximize share-
holder value as long-term investors. 
All investment professionals are responsible for the integration of ESG issues into the 
investment process, rather than outsourcing this responsibility to dedicated ESG or stew-
ardship specialists.
CASE EXAMPLE: MITSUBISHI MOTOR  
CORPORATION—AN AUTO MANUFACTURER
Mitsubishi Motor’s (MMC’s) competitive position had eroded materially over several 
decades. After being negatively affected by the Asian financial crisis in 1997, it faced a 
major defect cover-up scandal in Japan in 2016. In an unsuccessful attempt to improve a 
weak position in the developed markets, MMC then underwent a capital raising, which 
culminated in a recapitalization by the parent company. 
In recent years, MMC has taken steps to remain competitive by changing its production 
footprint and model range. MMC exited its developed-market production, reconfigured its 
domestic production, and shifted its focus to emerging markets. MMC is now a specialist pro-
ducer of sport utility vehicles, plug-in electric hybrids, and affordable cars for emerging markets. 
Notwithstanding this ongoing restructuring, significant governance, ethical, and 
social failures continued, exacerbated by an insular corporate culture with insufficient 
feedback between junior and senior management and insufficient board oversight. Shares 
were significantly de-rated from brand damage related to the fuel efficiency scandal in 
Japan (announced in early 2016). The scandal was the third known ethical transgression 
that the company had admitted to, and further highlighted the deficiencies in risk man-
agement and controls. The damage to MMC was compounded by negative cyclical earn-
ings factors, which further impacted market-pricing beliefs regarding the likely level of 
shorter-term earnings for MMC (see Figure 1).
In addition to the question of business ethics and management credibility, the market 
was also skeptical of MMC’s ability to remain as a competitive and viable standalone auto 
business based on its small scale of operations.

Mitsubishi Motors Corporation
47
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
Changes That Have the Potential to Be Supportive for 
Longer-Term Sustainable Returns
In October 2016, Nissan Motor Company Ltd. acquired a 34% share in MMC, becoming its 
largest shareholder. As what is now the third-largest global auto group, the alliance stands 
to benefit from scale advantages in parts procurement, and over the medium term, from 
FIGURE 1: MITSUBISHI MOTOR PRICE TO BOOK (RELATIVE) AND PRICE TO THE TOKYO STOCK 
PRICE INDEX (TOPIX) UNIVERSE
0
0.4
0.8
1.2
1.6
2
0
1
2
3
4
5
6
7
8
Jul-98
Mar-99
Nov-99
Jul-00
Mar-01
Nov-01
Jul-02
Mar-03
Nov-03
Jul-04
Mar-05
Nov-05
Jul-06
Mar-07
Nov-07
Jul-08
Mar-09
Nov-09
Jul-10
Mar-11
Nov-11
Jul-12
Mar-13
Nov-13
Jul-14
Mar-15
Nov-15
Jul-16
Mar-17
Nov-17
r_univPBR
PBR_ave
PBR_ave+1SD
PBR_ave -1SD
r_topixPRICE (RHS)
Abbreviations: ave, average; PBR, price to book (relative); RHS, right-hand side; SD, standard deviation; univ, 
universe.
Source: Eastspring Investments, as of 30 April 2018. The securities mentioned are included for illustration 
purposes only. It should not be considered a recommendation to purchase or sell such securities. There is no 
assurance that any security discussed herein will remain in the portfolio of the funds managed by Eastspring 
Investments (Singapore) Limited at the time you receive this document or that the security sold has not been 
repurchased.

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48
access to shared technology and research and development, as well as the use of common 
parts, modules, and platforms. 
The fuel economy scandal in 2016 forced a fundamental change at MMC through the 
introduction of an outside party (Nissan) with a credible restructuring track record. As 
a result, major changes have been made in the management structure, decision-making 
processes, and management oversight and internal communications; performance-based 
incentive structures have also been introduced. 
Our due diligence was conducted in early 2017, after MMC’s shares had been signifi-
cantly de-rated. Our strategies subsequently initiated an investment into MMC on the basis 
that the material risks we had identified (such as the lack of management credibility with 
a history of poor governance and business ethics, ongoing risk management and control, 
and MMC’s scale as a standalone auto company) were being addressed by new manage-
ment installed by Nissan. 
Our conviction levels were supported by our observation that the market was not fully 
recognizing or pricing-in the structural changes being made by MMC with regard to mate-
rial issues such as governance and business ethics, ongoing risk management, and the scale 
required to remain a viable business. This is an example of where changes to the market’s risk 
perceptions and expectations have caused a meaningful dislocation between the price and 
long-term trend valuation of a company, which offers an opportunity for the patient investor.
Engagement and ESG Improvement
MMC is not cited as a strong ESG performer but rather as a company that needs to address 
and improve its ESG performance. We continue to monitor and engage with MMC to test 
whether trend changes in structure and processes are being thoroughly implemented. 
We continue to look for changes to company culture, which are likely to protect minor-
ity shareholder interests, and we have signaled our position in our voting of proxies. For 
example, further progress is required with regard to governance structures and the level 
of independence of the board membership at both MMC and for the Nissan board. 
SUMMARY OF VALUATION PROCESS IN ACTION
Identify significantly mispriced opportunities based on valuation:
 
■
The 2016 scandal impacted share prices materially.
Understand the sources of market mispricing through deep fundamental analysis—
focus on materiality:
 
■
The market was not fully recognizing or pricing in the company’s structural 
responses to the various issues that were visible.

Mitsubishi Motors Corporation
49
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
Take a holistic approach that does not separate ESG risks from other material risks: 
 
■
Our trend valuation incorporated an assessment of a range of material financial 
and nonfinancial risks to sustainable earnings, including evidence relating to 
MMC’s willingness and ability to address trend issues such as governance and busi-
ness ethics; communication across business, ongoing risk management, and the 
scale required to remain a viable business brings high conviction for valuation.
Invest in high-conviction and high-valuation upside stocks to compensate for: 
 
■
material risks to sustainable earnings (financial and nonfinancial); and 
 
■
the time frame it may take to realize shareholder value.
Continue to engage with the investee company to encourage longer-term, sustainable 
value realization:
 
■
We can afford to be patient and exploit short-term share price volatility because 
of the high valuation upside and our high conviction levels regarding the likely 
sustainable earnings the company can generate. 
 
■
Value realization is encouraged via ongoing engagement with the company regard-
ing material issues. Our patient investment time frame is aligned with changes 
that occur in economic time frames—not financial industry time frames.

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50
THE GOLDMAN SACHS GROUP, INC.
NAVIGATING 21ST-CENTURY BUSINESS 
RISKS AND OPPORTUNITIES 
GS SUSTAIN
Since its inception in 2007, the aim of GS SUSTAIN (a proprietary research service of 
Goldman Sachs) has been to identify companies that can offer investors strong returns 
over long time horizons (3 years or longer). Our process includes quantitative screens and 
qualitative analysis to identify companies with persistent high returns on capital, access to 
growth, a durable competitive edge, and strong engagement on key environmental, social, 
and governance (ESG) issues. From Goldman Sachs Global Investment Research coverage 
of approximately 3,200 companies, we use this process to identify the “GS SUSTAIN 50”—
our list of long-term investment ideas. 
We believe that tomorrow’s industry leaders must be financially sound and operation-
ally excellent, but looking around corners to mitigate less conventional risks, such as envi-
ronmental and social risks, among others. For investors, ESG integration can help identify 
companies that are well placed to mitigate these risks and to benefit from any associated 
opportunities.
Over the last decade, we have found that integrating ESG into an investment 
analysis framework can offer valuable insights—for management and for investors—
into a company’s culture (e.g., talent attraction and retention, employee engage-
ment), operational excellence (e.g., resource efficiency), and risks (e.g., conflicts of  
interest, environmental impact, supply chain, data privacy, and climate change, 
among others). 
DISTINGUISHING BETWEEN ESG ENGAGEMENT  
AND ESG DISCLOSURE
Since the mid-2000s, a step change has taken place in the focus on ESG issues and data 
availability. As a result, a detailed corporate social responsibility (CSR) report is not neces-
sarily a signal of differentiated company engagement as it relates to underlying ESG risks. 
For investors or corporate managers seeking insight from ESG integration, it is critical 
to distinguish between companies that simply provide ESG disclosure and those that are 
truly engaged regarding the underlying risks and opportunities. 
This reality is highlighted in Figure 1, which shows that larger, mature companies are 
more likely to have a long CSR report, and that scoring companies on policies and targets 
alone without a materiality overlay does not add to alpha. Despite market-leading ESG dis-
closure, large companies based in Europe remain exposed to environmental catastrophes 
or governance scandals.

Navigating 21st-Century Business Risks and Opportunities 
51
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
In our investment process, we attempt to combat this scoring issue with a focus on the 
materiality of the metrics assessed, links to alpha generation, and the use of quantifiable 
performance metrics where possible (as opposed to a focus on disclosure of generic poli-
cies). For example, our quantitative Environmental and Social (E&S) framework for com-
pany evaluation uses an average of 14 material metrics that we have back-tested to ensure 
that they link to alpha generation.
USING ESG ANALYSIS TO PROVIDE INSIGHTS INTO  
THE SEMICONDUCTOR INDUSTRY
To give an example of our ESG analysis, we evaluated a leading manufacturer of critical 
components for the global semiconductor industry. We were initially attracted to the com-
pany due to its:
1. high returns on capital employed relative to sector peers;
2. high and stable market share and expanding gross profit and operating income 
margin, implying a competitive moat and pricing power; and 
3. good track record of capital allocation, including dividend payments, capital ratio, 
and reinvestment into the business at incrementally high rates. 
However, the company’s valuation was elevated; to achieve long-term value creation 
for investors, we needed to have a strong conviction regarding the company’s ability to 
maintain its industry-leading products and profitability.
Key operational risks that we identified included the maintenance of the com-
pany’s technical leadership through investment in human and physical capital, and the 
FIGURE 1: CORPORATE SOCIAL RESPONSIBILITY STATISTICS AND METRICS
0%
25%
50%
75%
100%
% with CSR report
0
10
20
30
40
50
60
70
Average page count
Performance outperforms policy metrics
CSR report statistics
–2.0%
–1.5%
–1.0%
–0.5%
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
Performance Metrics Targets
Policy Metrics
Material metrics included in our
framework
Avg. relative alpha  -best v. worst
Large companies
Small companies
Source: Bloomberg, Thomson Reuters, FactSet, Goldman Sachs Global Investment Research.

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52
potential for manufacturing delays or product defects that may impact its reputation and  
market share. 
We supplemented our analysis of these risks by using quantifiable E&S data. Within 
our E&S framework, the company scored as the best performer (100th percentile) among 
its sector peers in the MSCI ACWI index (representing large- and mid-capitalization com-
panies across 23 developed markets and 24 emerging markets countries). Through our 
framework, we derived further insights into the following aspects of the company: 
 
■
Asset quality and efficiency: We evaluated the company’s resource and emissions 
intensity to benchmark the efficiency of the company’s manufacturing assets 
versus those of its sector peers. We found that the company has industry-leading 
resource (water and energy) intensity per unit of revenue, higher performance 
regarding water and waste recycling, and lower carbon emission intensity than its 
peers. These conclusions helped support our view that the company was think-
ing beyond simple direct operating costs to consider its operations through a 
more expansive lens of looking at the indirect environmental performance of its 
operations.
 
■
Attracting and retaining talent: We evaluated employee engagement and com-
pensation to help gauge the risks associated with attracting and retaining talent. 
We found that the company’s average employee wage is significantly higher than 
its peers (100th percentile) and that it has low employee turnover (14th percen-
tile). In a highly complex research and development–intensive industry, this sug-
gests that the company is well positioned to attract and retain top talent, which 
could enhance the company’s innovation potential. The company receives positive 
reviews from current and former employees and appears to have embraced the 
reality that its employees are one of its most important assets, and that employee 
retention and satisfaction are fundamental to retaining its industry-leading 
position.
 
■
Business model: Looking beyond the numbers, we were encouraged by the company’s  
(1) positioning as enabling smaller, faster, and more energy-efficient electronics;  
(2) customer-centric approach of providing aftermarket enhancements and refur-
bishments to improve customers’ capital efficiency; and (3) culture of innovation 
and collaboration with internal and external stakeholders that have the potential 
to generate both new business opportunities and broader social benefits.
The findings from our ESG analysis supported our investment case for the company 
and helped moderate concerns regarding potential risks to the company’s competitive 
advantage and growth outlook. The company was ultimately added to a GS SUSTAIN list 
of industry leaders.

53
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
HIGH POINTE CAPITAL MANAGEMENT 
USING ESG CRITERIA TO ASSESS 
FRANCHISE QUALITY AND FAIR VALUE 
Gautam Dhingra, CFA
High Pointe Capital Management’s investment process was developed on the central prem-
ise that as the US economy made its transition from the manufacturing era to the infor-
mation era, more of the value of a company was going to shift to intangible assets (e.g., 
patents, brands, network effects, reputation, employee satisfaction) rather than physical 
assets (e.g., plant and equipment, inventory). This insight led our firm to create a metric 
called the Franchise Quality Score to measure a company’s intangible assets and use it as a 
key component of selecting stocks for the firm’s value-oriented investment strategy. 
THE FRANCHISE QUALITY SCORE
The Franchise Quality Score is calculated by assigning a value (on a scale of 1 to 5; a 
higher value indicates a higher-quality company) to eight component factors. These eight 
factors are designed to answer two all-encompassing questions:
1.	 How good is the business?
2.	 How well is it being managed for long-term success?
Figure 1 lists the components of the Franchise Quality Score and provides a brief 
description of the scale (1–5) used for scoring each factor. 
The factors of the Franchise Quality Score that address the question “How well is 
the business being managed for long-term success” automatically tilt High Pointe’s port-
folios toward companies that are good stewards from an environmental, social, and gov-
ernance (ESG) perspective. Governance is obviously a well-known ESG factor. The factor 
“Engagement with employees, community, and government” is also a key element of the 
social factors usually associated with ESG investing. 
High Pointe derives the composite Franchise Quality Score from this framework and 
uses it as an independent variable in a regression model that uses valuation, quality, and 
growth factors to identify undervalued stocks. Specifically, the regression model specifica-
tion is as follows (Equation 1):
	
P/E = α + β1(Franchise Quality Score) + β2(expected growth rate)	
(1)
This model establishes a fair price-to-earnings (P/E) for each stock in light of its 
Franchise Quality Score and expected growth rate. A comparison of fair P/E with the 
stock’s actual P/E reveals the degree of undervaluation or overvaluation for each stock.

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Below, we explain why this framework of evaluating the merits of a stock in light of its 
valuation, quality, and growth characteristics is not only logical but also mathematically 
consistent with the discounted cash flow (DCF) approach to stock valuation.
A COMPARISON WITH THE DCF MODEL
We start with a well-known DCF model; namely, the dividend discount model as shown in 
the following equation:
Dividend Discount Model: P = D0/(k – g)
(where P = price; D = Current dividend; k = discount rate; g = dividend growth rate)
By rewriting dividends as earnings multiplied by the payout ratio, we get:
P = (E × payout ratio) / (k – g)
FIGURE 1: FRANCHISE QUALITY SCORE FACTORS
HOW GOOD IS THE BUSINESS?
FACTOR
5
4
3
2
1
Barriers to entry
High
…
Medium
…
Low
Degree of competition
Benign oligopoly
…
Balanced
…
Cut-throat and 
fragmented
Pricing power vs. 
customers
Sellers’ market
…
Equilibrium
…
Buyers’ market
Pricing power vs. 
suppliers
Buyers’ market
…
Equilibrium
…
Sellers’ market
HOW WELL IS THE BUSINESS BEING MANAGED FOR LONG-TERM SUCCESS?
FACTOR
5
4
3
2
1
Management
Excellent track 
record
…
Unproven / 
mediocre
…
Poor record
Governance
Shareholder-
oriented
…
Mixed
…
Entrenchment 
mentality
Engagement with 
employees, community, 
and government
Partnership
…
Average
…
Short-term profit 
orientation
Sustainability of 
competitive advantage
Long-lasting
…
Medium
…
Short / 
unpredictable

Using ESG Criteria to Assess Franchise Quality and Fair Value 
55
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
Dividing both sides of the equation by E, we derive the following equation:
P/E = payout ratio / (k – g)
In its functional form, we can write this equation as follows:
P/E = fn (payout ratio, discount rate, growth rate)
If we make an assumption that the payout ratio is relatively constant over time and, there-
fore, not an important variable, we can further simplify this equation as follows (Equation 2):
P/E = fn (discount rate, growth rate) 
(2)
A comparison of High Pointe’s model represented by Equation (1) and the DCF model 
represented by Equation (2) makes clear that the valuation (P/E) of a stock is primarily a 
function of two main factors. One of these factors is growth. The other factor, according to 
High Pointe’s model, is Franchise Quality (while according to DCF, it is the discount rate).
The two models are actually quite consistent with each other, despite this apparent 
difference. This is because in the DCF model the discount rate is a proxy for risk, and 
High Pointe’s view is that its Franchise Quality Score is an ideal way to measure risk. The 
higher the Franchise Quality Score is, the lower the risk of a company is and, by implica-
tion, the lower its discount rate is.
Having established that growth and quality are the two most important factors that 
explain stock valuations, it is easy, then, to see that in this era when so much of the value 
of companies lies in intangible assets, a measure such as the Franchise Quality Score using 
ESG and other relevant factors is an ideal way to assess the value of companies.
SUMMARY
A company’s quality is one of the two dimensions of stock valuation. ESG factors are essen-
tial for determining whether the quality of a company’s business will be ephemeral or ever-
lasting. A holistic integration of ESG factors can help investors arrive at more accurate, 
long-term-oriented estimates of the fair value of each stock and, in doing so, improve their 
ability to outperform the market.

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56
HWABAO WP FUND MANAGEMENT CO., LTD.
NEW PERSPECTIVES UNDER  
HIGH-QUALITY DEVELOPMENT TREND  
IN CHINA: A CASE STUDY FOR  
APPLICATION OF ESG INVESTMENT IN  
THE AGROCHEMICAL INDUSTRY
Hwabao WP Staff
As environmental, social, and governance (ESG) investment criteria are still in the early 
stage of development in China, Hwabao WP Fund Management has committed to being 
a pioneer in this area. The Green Finance Committee of the China Society for Finance 
and Banking, led by Jun Ma, former chief economist at People’s Bank of China, is the 
first professional organization that aims to promote Green Finance Development research, 
product innovation, government policy, and industrial coordination in China. Hwabao 
WP Fund Management became a formal member of the Green Finance Committee of the 
China Society for Finance and Banking in 2017 and is now working to integrate ESG fac-
tors into its investment and research framework, to include both passive and active invest-
ments. The following describes the various developments with regard to ESG investing in 
China. 
BACKGROUND
Reasons for and Sustainability of a More Stringent 
Environmental Monitoring Mechanism
Following the 19th National Congress of the Communist Party of China in 2017, China has 
taken a top-down approach to governance on environmental protection; its approach can 
be divided into three levels: 
1.	 Treat pollution prevention as one of the three national critical battles, with the 
aim of controlling pollution levels within a certain range by 2020. 
2.	 Establish a long-term supervision mechanism. From state council to local govern-
ment, China plans to set up top-down environmental monitoring organizations 
to conduct regular inspections and supervision to ensure that government policy 
targets are achieved.

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© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
3. Establish assessment and ranking mechanisms to pursue “green” gross domestic 
product growth. China’s government will compile a quantitative ranking of pol-
lutants in provinces, municipalities, and autonomous regions, and will impose 
administrative penalties on those areas with low rankings. 
From these initiatives, we can conclude that environmental protection has become 
a “new normal” facet of China’s economic growth, and that this trend will continue for a 
long time.
Changes in the Competitive Pattern of China’s Chemical 
Industry under the New Governance
Since 2016, the Ministry of Environmental Protection of China has conducted several 
rounds of environmental inspections. In the chemical industry, the main inspection targets 
include highly polluting enterprises and chemical industrial parks. To achieve its goals, the 
Ministry of Environmental Protection imposes various sanctions on enterprises that fail to 
meet emission requirements or lack environmental protection equipment. These sanctions 
include financial penalties, factory shutdowns, and company rectifications.
The agrochemical industry represents a typical industry affected by China’s more strin-
gent environmental supervision. For instance, the Environmental Protection Department 
of Jiangsu Province shut down the local chemical industrial parks for inspection purposes 
in March 2018. This shutdown involved 70 agrochemical companies (about 13% of the 
local chemical industry)—far above the national average level of 1.3%.
From a short-term perspective, the price of pesticide products will increase after 
the government shuts down those chemical industrial parks; in the long term, the lead-
ing agrochemical companies that complied with the environmental protection standards 
will improve their market share, bargaining power, and profitability after such supply-side 
reforms.
CASE EXAMPLE: INTEGRATING ESG FACTORS AND 
CHINA’S REGULATORY CHANGES INTO EQUITY 
VALUATION
From an equity valuation analysis perspective, we will use an A-share-listed agrochemical 
firm, Company B, to illustrate how the regulatory changes in China’s environmental pro-
tection mechanism would be integrated and what the impact on the industry’s competitive 
structure would be.
Company B’s major business is the production and sale of agrochemical products, 
including insecticide, herbicide, and other agrochemical products. Major clients are down-
stream preparations, focusing on exports. Because of its advanced production technol-
ogy, highly efficient production line, and high environment protection standards (higher

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than the industrial average), Company B is always ranked in the first tier of China’s agro-
chemical industry. The company’s Product A (insecticide) sales volume is ranked first in 
China and second in the world. Its Product B (herbicide) sales volume is increasing, having 
become more popular based on the product’s high efficiency and low level of toxic ingredi-
ents. Figure 1 shows the company’s main product structure.
Under the influence of China’s new environmental protection mechanism, Company 
B’s profitability will change in two ways. First, Company B will see an increase in its short-
term profitability—agrochemical product prices will increase immediately following the 
shutdown of unqualified agrochemical companies. Second, the company’s revenue and 
return on equity will increase in the long run after Product A reaches its target production 
capacity. Following the withdrawal of production capacity not compatible with the new 
environmental protection mechanism, the concentration ratio of the whole industry will 
increase. Thus, Company B can ensure its leading position in the industry and increase its 
market share.
SEIZING SIMILAR INVESTMENT OPPORTUNITIES IN 
LIGHT OF THE NEW ENVIRONMENTAL PROTECTION 
MECHANISM
Previously, most ESG research was conducted to avoid risk, especially in the fixed-income 
market. However, it is also important for equity portfolio managers to pursue excess 
returns by integrating ESG factors into the investment decision-making process. We have 
the opportunity to explore a broader range of investment opportunities because China 
is on track to improve its environmental protection standards. Referring to the equity 
FIGURE 1: PRODUCT STRUCTURE OF COMPANY B
PRODUCT
REVENUE 
PERCENTAGE  
(%)
GROSS 
MARGIN  
(%)
MARKET SHARE
Product A (insecticide)
43.0
45.6
Will achieve the world’s largest production 
capacity after reaching new target level of 
production capacity.
Market share: more than 50%.
Product B (herbicide)
44.7
50.3
World’s largest production capacity.
Market share: more than 50%.
Others 
12.3
4.2
…
Source: Annual report; both Product A and Product B have entry barriers and comply with the new environ-
mental requirements.

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© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
valuation analysis example above, if we sort China’s publicly listed companies (especially 
those with excess capacity, low industry concentration, high pollution, high energy dissipa-
tion, and high emissions problems seen in traditional industries) by using factors such as 
related production capacity, product segmentation, and market share (among others), we 
can adjust our forecast of the short-term product price trend and the industry’s long-term 
competitive structure based on the progress of China’s environmental protection super-
vision. Then, we can amend our company-specific valuation model to uncover potential 
investment opportunities.

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INFLECTION POINT CAPITAL MANAGEMENT 
STRATEGICALLY AWARE INVESTING 
Matthew Kiernan
Companies need new approaches and strategies if they are to retain their social license to 
operate, and to remain competitive and profitable. Investors, in turn, require new assump-
tions, approaches, and tools to identify the winning—and losing—companies of tomorrow. 
THE INVESTMENT THESIS
Inflection Point Capital Management’s (IPCM’s) investment approach requires that con-
ventional financial analysis be supplemented by the addition, analysis, and seamless inte-
gration of two critical, “nontraditional” risk and return drivers:
1.	 Companies’ performance and strategic positioning with regard to five key 
components of the “intangible value,” which academics believe currently con-
stitutes 75%–80% of companies’ true risk profile and value-creation potential, 
yet are generally not captured in financial statements. Those five attributes 
are environmental sustainability, human capital, organizational capital, adapt-
ability and responsiveness, and innovation capacity. 
2.	 Companies’ relative exposure to both the downside risks and upside opportu-
nities created by a series of powerful, secular global megatrends such as pop-
ulation growth and demographic change, climate change, natural resource 
depletion, urbanization, and the expansion of new middle classes in countries 
such as China and India. 
THE INVESTMENT PROCESS
Step 1: Alpha Pool Generation
This process is largely quantitative, designed to winnow the investable universe 
(approximately 2,500 companies) down to a more tractable number—about 230–250 
companies. This winnowing process applies to both sustainability and financial assess-
ments, and uses data largely generated by third parties. At this stage, the financial fac-
tors receive significantly more weight. This reasoning is straightforward: we see little 
sense in allocating resources to an in-depth assessment of the sustainability charac-
teristics of companies whose poor financial data would render them noninvestable 
regardless of any sustainability merits they might possess. The outcome of Step 1 is the 
creation of an “Alpha Pool” of 230–250 names that we believe justify further, deeper 
in-house analysis.

Strategically Aware Investing 
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© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
Step 2: Focus List Generation
This phase of the analysis is much more qualitative, and is composed of three strands: tra-
ditional financial analysis; a “5-factor” assessment of key intangibles (see Figure 1); and an 
assessment of relative megatrends exposures, both positive and negative. 
It should be noted that at least three of the five factors in the IPCM model go beyond 
the dimensions typically captured by environmental, social, and governance (ESG) analy-
sis: organizational capital, adaptability and responsiveness, and innovation capacity. We 
consider all three to be critical capabilities for competitive and financial success in the 21st 
century, and therefore worthy of a systematic comparative analysis.
During this phase, in addition to the “nontraditional” factors noted in Figure 1, more 
traditional factors are assessed in depth, including balance sheet strength, profitability, 
earnings quality, the competitive dynamics of the particular industry sector, and valua-
tions. The outcome of Step 2 is the creation of a smaller “Focus List” of 120–130 names.
Step 3: Balancing Sector and Geographic Exposures
At Step 3, particular emphasis is given to ensuring that both the sectoral and geographic 
exposures of any potential portfolio are ones that the portfolio manager and chief invest-
ment officer are comfortable with. This is also true of the correlations among the stocks 
themselves, which are examined to ensure that the portfolio is sufficiently diversified in 
terms of risk factors. This is a particularly quantitative part of the process, and we receive strong 
support from the investment analysis group’s financial engineering and risk control teams.
FIGURE 1: IPCM’S 5-FACTOR MODEL
Financial
results
Innovation
capacity
Adaptability &
responsiveness
Environmental
sustainability
Human
capital
Organizational
capital

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Step 4: Portfolio Construction
Taking into account all of the factors reviewed during Step 3, a final portfolio of approxi-
mately 60–70 names is constructed. The timing of the actual stock purchases is dictated by 
the then-current valuation levels.
It is important to note that with the exception of Step 1 where financial considerations 
predominate, financial and nontraditional factors receive roughly equal weight through-
out the rest of the decision-making process. 
A COMPANY EXAMPLE
It may be instructive to illustrate, in an extremely summarized form, the application of 
the 5-Factor and global megatrends models to a specific company case. The example we 
have chosen is a UK-headquartered specialty chemicals company, which operates in the 
premium, high-margin segment.
We have been studying the key secular global megatrends and their company-specific 
impacts for many years and have identified at least five megatrends that provide a “tail-
wind” for the company’s products and services:
1. demographic shifts—growing customer demand for more environmentally sus-
tainable products; 
2. emergence of more affluent middle classes in several emerging markets;
3. climate change;
4. growing demand for clean water; and
5. growing demand for food, especially in emerging markets.
We believe that each of these external structural changes promises to unfold to the 
benefit of the company going forward. We then turn to the company’s performance and 
strategic positioning on each element of the 5-Factor model.
1. Environmental sustainability is the first of IPCM’s five factors. In this case, we 
judged the company to be a strong performer: its carbon intensity is lower than 
its subsector industry average, and its energy efficiency is superior because of its 
materials-use efficiency. An emphasis on renewable feedstocks permeates the com-
pany’s entire product development strategy; as a direct result, it derives a sector-
leading 63% of its raw material inputs from renewable sources, such as a bio-based 
ethylene oxide.
2. Human capital management is similarly strong. The company devotes an excep-
tional volume of resources to staff training and development; 86% of the staff 
receives some sort of training each year. The company also has a high level of 
participation in the employee shares program—84% in the United Kingdom. We 
were also favorably impressed by the company’s recruitment and retention strate-
gies, which are explicitly designed to promote diversity in its workforce.
3. The company has created valuable organizational capital by devoting consider-
able energy to the sharing of a variety of performance data with its customers;

Strategically Aware Investing 
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© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
therefore, it is hardly surprising that its customer relations are well above average 
compared to its sector peers. The same is true with its supply chain: the company 
makes extensive use of enhanced life-cycle analysis, where both social and envi-
ronmental impacts are calculated and monitored, and corrective action is taken 
where necessary. One example of this is the firm’s aggressive efforts to ensure that 
its supplies of palm oil are secured through sustainable methods. 
4. Adaptability and responsiveness are most visible in the company’s early recogni-
tion of and adaptation to several key megatrends. One example is the growing 
global concern regarding both the quantity and quality of fresh water, to which 
the company responded rapidly by engineering a number of new water purifica-
tion technologies, chemicals, and products. 
5. Evidence of the firm’s innovation capacity is provided by its major strategic 
emphasis on “green chemistry” in product development, which has meant that 
fully 65% of the company’s new products are driven primarily by sustainability 
considerations—new water treatment chemicals and low volatile organic com-
pound coatings are just two examples.

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MANULIFE ASSET MANAGEMENT 
HOW THE “G” FACTOR AFFECTS  
THE EQUITY VALUATION MODEL:  
A NORTH AMERICAN SOFTWARE  
COMPANY CASE STUDY
Patrick Blais, CFA; Christopher Mann, CFA; and the Canadian Core Team
Manulife Asset Management’s Canadian Core investment team’s approach to environmen-
tal, social, and governance (ESG) analysis, incorporated within individual stock funda-
mental analysis, hones in on quantifiable and material ESG factors that may impact future 
free cash flow generation and cash flow return on investment. Good corporate governance 
and incentive compensation are viewed as critical to help drive effective capital allocation 
decisions. The investment team’s approach to effective stewardship of capital includes an 
engagement practice that fosters a constructive dialogue with company management to 
address relevant ESG issues. 
This practice is in line with Manulife Asset Management’s global ESG policy, 
which states our belief that successful companies in the long term will have a strong 
and effective board, good internal controls, effective remuneration structures in line 
with long-term performance, high-quality and meaningful reporting to sharehold-
ers and other stakeholders, and good management of the environmental and social 
aspects of their business. 
BACKGROUND TO THE INVESTMENT CASE
An acquisitive technology holding in the investment team’s portfolio experienced material 
share price underperformance relative to its peers, with the shares trading at a significant 
discount to the peer group. The investment team initiated a formal review process, which 
incorporated an ESG analysis.
The review determined that the share price underperformance was linked to declin-
ing return on investment capital (ROIC). Although the company had historically generated 
a relatively stable ROIC of 20%, its returns have declined to the low teens (see Figure 1), 
levels that are currently at least 2% lower than that of its peers. Based on the investment 
team’s analysis, it was determined that the lower ROIC was the result of the relatively high 
price paid for recent acquisitions, a departure from the more disciplined approach previ-
ously taken by the company. This led the investment team to more closely consider certain 
governance issues, specifically incentive compensation structures and the impact on valua-
tion multiples paid for acquisitions.

How the “G” Factor Affects the Equity Valuation Model: A North American Software Company Case Study 
65
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
POTENTIAL CORPORATE GOVERNANCE ISSUES 
RELATED TO INCENTIVE COMPENSATION
A review of management’s compensation structure concluded that the company’s incentive pro-
grams were potentially failing to incentivize the necessary discipline surrounding acquisitions.
 
■
Short-term incentive compensation was based on revenue targets and adjusted oper-
ating income targets. In the investment team’s opinion, these absolute-dollar metrics 
were considered poor drivers of shareholder value creation. In addition, the adjusted 
metrics ignored the majority of amortization costs associated with acquisitions. The 
investment team was concerned that this short-term incentive plan could induce man-
agement to pursue acquisitions while overlooking their price and valuation. 
 
■
Long-term incentive compensation was linked to absolute and relative stock per-
formance over a three-year period. This, and the fact that the long-term incen-
tive was more than three times the size of the short-term incentives, could align 
management with shareholder value creation. However, the investment team was 
concerned that without a clear link to critical operational metrics and given the 
subjective nature of the overall amount initially granted, this long-term incentive 
could encourage management to take on excessive risk, as demonstrated by the 
increase in leverage to fund recent acquisitions. 
FIGURE 1: COMPANY’S RETURN ON INVESTED CAPITAL (BASED ON HISTORICAL 
CALCULATIONS PERFORMED BY MANULIFE’S INVESTMENT TEAM) 
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
2011
2012
2013
2014
2015
2016
2017
Q1 2018 Q2 2018 Q3 2018
Note: “Any one-time deferred tax gains” are removed to prevent distortion of the recurring financial metrics 
of the company.
Source: Manulife, May 2018.

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The investment team took the view that the company should improve the link between 
management incentive compensation and clear drivers of shareholder value creation. In 
the investment team’s experience, companies sometimes overemphasize absolute dollar 
and growth targets and underemphasize free cash flow generation and returns. Given the 
material impact of acquisitions on company returns, the investment team determined that 
it would be beneficial to have some portion of incentive compensation linked to ROIC (see 
Figure 1).
RESPONSE TO GOVERNANCE CONCERNS
The investment team engaged with company management in 2018 to encourage linking 
executive compensation to ROIC, which would in turn demonstrate to shareholders that 
company management had a long-term focus, and its actions and capital allocation deci-
sions were in alignment with shareholder interests.
The company was responsive to the concerns raised—including the comments on tying 
compensation to ROIC—and noted that a review was underway to determine compensation 
items for fiscal year 2019. Part of this review also included whether to provide additional 
disclosure (such as an organic growth figure), which should help alleviate the fear that the 
underlying business may be deteriorating faster and contributing to the declining ROIC.
KEY TAKEAWAYS
We believe that a constructive, open dialogue with a company, demonstrating how strong 
governance measures around executive compensation are considered by investors, can 
help provide solutions for both the investee and the investor. 
Although this case analysis is ongoing, we are encouraged by the open dialogue and 
hope that the company will take active measures to improve disclosure and executive com-
pensation measures to demonstrate that it believes it can restore ROIC closer to the histor-
ical level of about 20%. The Manulife Asset Management investment team feels confident 
that if such a plan can be executed, it could be a major driver for improving capital alloca-
tion decisions and, in turn, shareholder results, versus other proposals (such as deploying 
more capital into even more acquisitions).

67
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
MFS INVESTMENT MANAGEMENT 
INEQUALITY, OUTSOURCING, AND 
INDIAN IT SERVICES COMPANIES 
Rob Wilson
At MFS Investment Management, our approach to environmental, social, and governance 
(ESG) integration has always been built on a foundation of in-depth, bottom-up research on 
individual securities. We strongly believe this bottom-up, materiality-driven approach, rather 
than one based heavily on ESG ratings, leads to true ownership of ESG issues among our 
industry analysts and portfolio managers. As a result, we have developed a detailed and com-
prehensive ESG integration strategy designed to enable the broader investment staff to better 
understand how ESG issues can impact their decision-making process. The framework for 
this strategy is supported by both analytic and systematic elements (Figure 1).
INEQUALITY AND OUTSOURCING: REASSESSING COST 
FORECASTS AND DEVELOPING SCENARIO ANALYSES
The topic of income and wealth inequality has garnered increased attention recently.1 Although 
data suggest that global inequality has decreased over the past few decades, inequality appears 
to have increased within many individual developed-markets countries. This increase appears to 
1 Marcelo Giugale, “Piketty, Stiglitz and Our Renewed Interest in Inequality,” The World Bank (13 May 2015). 
www.worldbank.org/en/news/opinion/2015/05/13/piketty-stiglitz-and-our-renewed-interest-in-inequality
FIGURE 1: MFS’ ANALYTIC AND SYSTEMATIC ESG STRATEGY FRAMEWORK
Bottom-Up
Fundamental
Research &
Engagement
Analytic
Systematic
Industry Initiations
Ad Hoc Research Requests
ESG in Depth
Sector/Thematic Research
ESG Portfolio Dashboards
ESG Security Dashboards
Semiannual risk reviews led
by quantitative team
Systematic distribution of
external ESG rating changes
ESG tab in research notes for
companies\issuers
Automated distribution of
low-rated securities reports

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have at least partially impacted some recent political outcomes,2 while also affecting the debate 
surrounding a wide variety of topics such as drug pricing, outsourcing, and immigration. Given 
the potentially broad impacts of this social issue, investors should consider where and when 
inequality-related topics might need to be considered in their modeling and valuation analysis, 
as exemplified in this case study on the information technology (IT) outsourcing industry.
INEQUALITY’S IMPACT IN DEVELOPED MARKETS
Thomas Piketty’s oft-questioned3 but unquestionably popular4 book, Capital in the Twenty-
First Century, set off a debate on the long-term consequences associated with increased 
inequality. An independent review of the available data appears to suggest that income 
inequality has increased in many developed markets,5,6 even though global inequality 
appears to be falling.7,8 Although the decrease in global inequality is clearly positive from a 
social perspective, growing inequality in developed markets appears to be driven by struc-
tural factors, such as increasing automation, ongoing penetration of outsourcing activities, 
and a declining unionization rate, which could further exacerbate the risk of this issue for 
investors whose portfolio companies operate in developed countries. As a result, investors 
need to understand the potential drivers of inequality to properly assess which investments 
may be at risk—or which may provide an investment opportunity—as a result of this issue.
RISKS IN THE OUTSOURCING BUSINESS MODEL
Based on both academic research9 and other media reports,10 outsourcing is a topic that 
is often intertwined with the broader discussion regarding inequality. Recent political 
2 Mark Scott and Charlie Cooper, “Brexit Is an Opportunity to Tackle Inequality,” Politico (updated 24 
December 2017). www.politico.eu/article/brexit-theresa-may-eu-european-union-leave-u-k-britain-uk-article-
50-david-davis/
3 Jon Hartley, “Why Economists Disagree with Piketty’s ‘r-g’ Hypothesis on Wealth Inequality,” Forbes (17 
October 
2014). 
www.forbes.com/sites/jonhartley/2014/10/17/why-economists-disagree-with-pikettys-r-g- 
hypothesis-on-wealth-inequality/#6d3054a56c40
4 Megan McArdle, “Piketty’s Capital: An Economist’s Inequality Ideas Are All the Rage,” Bloomberg 
Businessweek (30 May 2014). www.bloomberg.com/news/articles/2014-05-29/pikettys-capital-economists- 
inequality-ideas-are-all-the-rage
5 Jared Bernstein and Ben Spielberg, “The Whys of Increasing Inequality: A Graphical Portrait,”
Washington Post (14 August 2017). www.washingtonpost.com/news/posteverything/wp/2017/08/14/the- 
whys-of-increasing-inequality-a-graphical-portrait/?noredirect=on&utm_term=.7db7eead44db
6 “20 Facts About U.S. Inequality That Everyone Should Know,” Stanford Center on Poverty and Inequality 
(2011). https://inequality.stanford.edu/publications/20-facts-about-us-inequality-everyone-should-know
7 “Poverty,” The World Bank (last updated: 11 April 2018). www.worldbank.org/en/topic/poverty/overview
8 Laurence Chandy and Geoffrey Gertz, “Two Trends in Global Poverty,” Brookings (17 May 2011). www.brook-
ings.edu/opinions/two-trends-in-global-poverty/
9 David H. Autor, David Dorn, and Gordon H. Hanson, “Untangling Trade and Technology: Evidence 
from Local Labor Markets,” National Bureau of Economic Research Working Paper No. 18938 (April 2013).  
www.nber.org/papers/w18938
10 Nicholas Bloom, “Corporations in the Age of Inequality,” Harvard Business Review. https://hbr.org/cover-
story/2017/03/corporations-in-the-age-of-inequality

Inequality, Outsourcing, and Indian IT Services Companies  
69
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
debate11,12 on outsourcing has caused a number of firms in the IT outsourcing industry to 
adjust their business strategy to avoid political risks and improve their reputation in the 
countries in which they operate. This change in strategy has primarily taken the form of 
“localization,” where employees are hired and work within the country where they gener-
ate revenue. Given the historical and current cost benefits associated with outsourcing cer-
tain technical skills, increasing localization due to growing concerns regarding inequality 
will have an impact on the future staffing costs for companies that offer IT outsourcing 
solutions.
In our modeling of the India-domiciled companies in the IT services industry (Figure 2), 
we chose to increase our run rate of wage-related costs by approximately 1% annually to 
account for an increase in employee localization from about 33% today to 50% over the 
next few years. Assuming no productivity or other offsets, this change would decrease our 
earnings projections for these companies by about 3%. Although this base-case modeling 
impact is relatively small, we considered a range of potential cost and earnings impacts, 
given the risks associated with inequality. For example, given the specific focus on H-1B 
visas (which allow US employers to employ foreign workers) and the importance of that 
market to the IT outsourcing industry, we also reviewed various scenarios to assess the 
potential risks of regulatory changes regarding visa availability. We believe a 7%–8% 
decrease in earnings is the most probable additional downside earnings risk based on this 
specific H-1B–related visa issue.
Although we view inequality as a financially material risk for companies in the IT 
outsourcing industry, we still believe some of these companies are attractive investments 
and that their valuations already reflect some of these issues. We expect these companies 
will continue to see growing demand for their services as more companies struggle with 
the complexity of IT system implementation, change management, and maintenance. We 
also believe the higher-quality management teams in this industry will be able to with-
stand the risks associated with inequality by anticipating and appropriately localizing their 
11 Joshua Brustein, “Trump’s H-1B Reform Is to Make Life Hell for Immigrants and Companies,” 
Bloomberg 
(6 
November 
2017). 
www.bloomberg.com/news/articles/2017-11-06/trump-s-h-1b-reform-is- 
to-make-life-hell-for-immigrants-and-companies
12 Jim Pickard, “UK Will Review Tier 2 Visa System, Says Sajid Javid,” Financial Times (3 June 2018). www.
ft.com/content/5089896e-6714-11e8-b6eb-4acfcfb08c11
FIGURE 2: BASE-CASE AND DOWNSIDE-RISK SCENARIOS
• 1% cost increase
• 3% EPS reduction
Base-Case
Impact
• Regulatory
changes lead
to 7%-8% EPS
reduction
Downside-Risk
Scenario

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workforces. For example, our highest-rated company in this industry’s peer group is a firm 
whose management team has recognized this risk and has articulated the clearest set of 
goals to increase localization. Although this approach will not necessarily improve its cost 
profile versus its peers over the near term, we do believe it shows a deeper understand-
ing of the long-term threat to the business model posed by the issues of outsourcing and 
inequality.
Finally, we believe these companies have been positive contributors to the global 
decrease in inequality, as they offer a large number of high-quality jobs to individuals in 
emerging-market countries.

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MOMENTUM INVESTMENTS 
INTEGRATION OF DIRECTOR EQUITY 
PARTICIPATION IN COMPANY VALUATION
Piet van der Merwe
Environmental, social, and governance (ESG) integration is part of a fundamental com-
pany analysis. To list it as a separate factor is to negate the very concept of integration. 
Therefore, the quality of management must be considered an important factor in the 
evaluation of potential investment targets. Top company management sets the culture and 
tone of the company, which in turn establishes whether any ESG factors are integrated into 
the company’s strategy and operations. Yet many analysts prefer to recommend investment 
decisions based only on “hard figures” gathered from financial statements rather than 
additionally integrating the more subjective issues relating to management remuneration 
and performance.
In times of economic difficulty, management rewards are always scrutinized and criti-
cized. At times this is unfair, but in other instances it is warranted, because remunera-
tion as an expense directly affects the shareowners of a company and touches on societal 
or moral issues. Recently, in two South Africa cases, remuneration issues led to dramatic 
reversals in company market valuations.
Companies may assume that executive directors, who usually have substantial per-
sonal stakes in companies, will be incentivized to better manage the company on behalf of 
shareholders as a result of economic alignment of interests. However, when the executive 
positions are extensively leveraged, the sheer size of the executive interests may result in 
trades that adversely affect the share price.
INFORMATION TECHNOLOGY OUTSOURCING VALUATION
The first example of such an unforeseen consequence was seen in a company specializ-
ing in outsourced information technology solutions. The board structure was not opti-
mal, with more than half of the board consisting of executive directors. This created the 
potential—even if unintentional—result that the interests of management would carry 
more weight than those of other shareholders.
In December 2017, excessive selling of company shares occurred in the market over a 
period of days. Outside the world of short sellers, this was unusual. Shareholders seldom 
trade in volumes detrimental to the share price of their own investment.
The effect of trades in the share price can be seen in the share price charts. Figures 1 
and 2 cover December 2017, which illustrates the stock’s daily share price and trades. After 
3 days of intense short selling, the closing share price had declined by 38.7%.

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FIGURE 1: DAILY SHARE PRICE AND TRADES
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
1-Dec-17
7-Dec-17
13-Dec-17
19-Dec-17
25-Dec-17
Price in ZAR 
(cents)
FIGURE 2: THE TRADING VOLUMES DURING THAT PERIOD
1-Dec-17
7-Dec-17
13-Dec-17
19-Dec-17
25-Dec-17
0
1,000,000
2,000,000
3,000,000
4,000,000
5,000,000
6,000,000
Trading volume
After the short-selling wave, a South African news service (FIN 24) (11 December 2017 
by Jan Cronje) reported “the stock of EOH, an information and communications technol-
ogy services provider, dropped from ZAR69.51 on Thursday morning to just ZAR30.95 on 
Friday morning, a fall of 55%. The price recovered somewhat during trade on Friday and 
shot up to ZAR60.78 as of 11:00 on Monday, just 12% below its opening price on Thursday.”
After days of speculation, the company confirmed that the dramatic collapse was 
not due to hedge fund short sellers but because of forced margin call sales by company 
directors. 
The Johannesburg Stock Exchange issued a SENS announcement, which confirmed 
the news reports, the gist of which is provided in Figure 3.

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FIGURE 3: JOHANNESBURG STOCK EXCHANGE SENS ANNOUNCEMENT

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FIGURE 4:  COMPANY SHARE PRICE AND TRADING VOLUMES FROM 1 DECEMBER 2017 TO  
26 APRIL 2018
0.00
2,000.00
4,000.00
6,000.00
8,000.00
10,000.00
12,000.00
14,000.00
16,000.00
1-Dec-17
1-Jan-18
1-Feb-18
1-Mar-18
1-Apr-18
Price in ZAR 
(cents)
At the company’s annual general meeting on 12 April 2018, the shareholders made 
their displeasure known, as the remuneration policy and the implementation thereof was 
nearly voted down. The votes against the implementation of the remuneration policy were 
44.9%, with 6.2% of shareholders abstaining.
Management was also aware that the shareholders were extremely unhappy with the 
current board structure. The company planned to appoint more nonexecutive directors 
and reduce the number of executive directors in the future.
PROPERTY VALUATION
In this second case, a property company leveraged structures that formed part of an incen-
tive scheme, which led to reputational consequences, resulting in a severe drop of the  
stock price. 
The company had an incentive scheme whereby employees could borrow 20 times 
their annual remuneration to buy stock in the company. For example, the CEO (earning 
a total package of ZAR30 million) could buy ZAR600 million worth of company stock 
with money advanced by the company. The group structure and pattern of buying and 
selling within the group of companies made some investors suspicious that the trades were 
intended to benefit management’s leveraged equity positions and to enable managers to 
pay back the loaned funds on time. 
For shareholders and regulators, it is difficult to differentiate between rational buying 
and manipulation, because these types of remuneration structures persist. The rumors of 
the use of group structures and remunerations had a cumulative negative effect on the 
share price, as shown in the price chart in Figure 4.

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75
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
The share price closed at ZAR127.77 on 1 December 2017 and traded at ZAR59.04 at 
the end of April 2018, a decline of 46.2%. 
Momentum Investments has consistently voted against these remuneration structures 
at shareholder meetings. These structures do not necessarily work to the advantage of 
either shareholder returns or the reputation of management. Consequently, the risk may 
affect the size of our holdings in companies that allow their directors to leverage positions 
in their company’s stock. 
CONCLUSIONS
 
■
Company executives should not be able to take sizeable leveraged positions in the 
companies they manage on behalf of all shareholders.
 
■
If they do take leveraged positions, compliance measures should be in place to 
prevent the consequences described in the given examples. 
 
■
From Momentum Investments’ perspective, such remuneration structures do 
affect the valuation, as well as the size of Momentum Investments’ holding in a 
company.
 
■
In the case of the information technology outsourcing company, the portfolio 
manager made the decision to hold only a small number of shares in the company 
until further notice.
 
■
In the case of the property company, no shares were sold from the portfolio 
because the decline in the share price automatically down-weighted the counter 
value in the listed property portfolio to a level the portfolio manager was comfort-
able with.

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NISSAY ASSET MANAGEMENT CORPORATION
INTEGRATING ESG FACTORS 
CONSIDERATION INTO EQUITY VALUATION
Toshikazu Hayashi
In 2008, Nissay Asset Management (Nissay AM) introduced environmental, social, and 
governance (ESG) analysis (mainly a three-point-scale ESG rating system) of Japanese-
listed equities by in-house analysts covering more than 500 names from the viewpoint of 
corporate value enhancement. In the ensuing 10 years, the rating methodology has been 
improved, and approximately 20 in-house analysts now conduct financial forecasts for the 
next five years by reflecting ESG analysis, to calculate intrinsic value based on discounted 
cash flow methodology. 
Because the materiality of ESG issues differs by sector (and even for individual com-
panies), each analyst drills down into the relationship between ESG factors and long-term 
financial forecasts, adjusting revenue growth forecasts, operating margin forecasts, capital 
expenditures forecasts, and other forecasts, and adjusts cash flow forecasts accordingly.
Figure 1 shows the relationship between Nissay AM’s ESG rating and its fifth year’s 
(i.e., year t+5) cash flow return on investment (CFROI) forecasts. Companies with the high-
est ESG rating (ESG rating 1) have relatively higher levels of CFROI forecasts than oth-
ers. Companies with high ESG ratings are also likely to have wider discrepancies between 
their intrinsic value and market price, which means more upside opportunities are avail-
able (Figure 2). Furthermore, a breakdown of historical stock return of Nissay AM’s ESG 
ratings universe demonstrates that companies with the highest ESG ratings have outper-
formed those with ESG ratings of 2 or 3 since Nissay AM introduced the ESG rating system 
in December 2008 (Figure 3).
INTEGRATING THE EFFECT OF THE RAPID EXPANSION 
OF RENEWABLE ENERGY INTO FINANCIAL FORECASTS
The following case illustrates an example of a Japanese machinery maker whose main 
products are high-efficiency gas turbines and thermal power plants. Conventionally, gas-
fired products with high energy-conversion efficiency provide competitive advantages 
over their peers and therefore enhance corporate value. However, the rapid expansion 
of renewable energy led to a sharp decline in the demand for coal power plants as well as 
natural gas power plants, and the company faced sluggish orders for its high-efficiency gas 
turbines. Considering such a transformational change, the analyst demoted the environ-
mental (E) rating of the company. Furthermore, because the company had failed to pro-
vide timely growth strategy updates in response to these structural changes (being behind 
in labor reallocation and fixed costs optimization in the industry), the analyst also decided

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FIGURE 1: ESG RATING AND FIFTH YEAR’S CFROI FORECASTS (AS OF SEPTEMBER 2016)
0%
2%
4%
6%
8%
10%
ESG rating 1
ESG rating 2
ESG rating 3
CFROI forecast—EWA (%)
Abbreviation: EWA, equally weighted average.
Note: ESG rating 1 = highest rating.
Source: Nissay Asset Management.
FIGURE 2:  ESG RATINGS AND EXPECTED STOCK RETURNS (DISCREPANCY BETWEEN 
INTRINSIC VALUE AND MARKET PRICE) (AS OF SEPTEMBER 2016)
0%
5%
10%
15%
20%
25%
30%
35%
ESG rating 1
ESG rating 2
ESG rating 3
Expected return—EWA (%)
Note: ESG rating 1 = highest rating.
Source: Nissay Asset Management.

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to demote the governance (G) rating of the company. As a result, the overall ESG rating 
was demoted from the highest rating to a middle rating.
Following the downgraded ESG ratings, the analyst updated the company’s financial 
forecast (i.e., revenue growth and operating margin for the next five years), which indi-
cated a decline in CFROI forecasts (Figure 4) and an expected stock return decline of 
more than 30%; thus, the analyst reconsidered the investment recommendation. 
ESG integration makes it possible to reflect a company’s long-term perspective in its 
intrinsic value, leading to more appropriate investment decision making.
FIGURE 3: ESG RATINGS AND AVERAGE ANNUALIZED RETURNS (COMPARED 
TO ESG RATING UNIVERSE)
–1.0%
–0.5%
0.0%
0.5%
1.0%
1.5%
ESG rating 1
ESG rating 2
ESG rating 3
Annualized cumulative return (%)
Notes: ESG rating 1 = highest rating. Returns are calculated based on equally weighted monthly rebalancing 
portfolio from December 2008 to March 2018.
Source: Nissay Asset Management.

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FIGURE 4: ESG RATING UPDATES AND CHANGES IN CFROI FORECASTS
–1%
0%
1%
2%
3%
4%
5%
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017E
2018E
2019E
2020E
2021E
C FROI (%)
Source: Nissay Asset Management.

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NN INVESTMENT PARTNERS
ALUMINUM STOCK CARBON PRICE CASE 
Matt Huston and Willem Schramade
This aluminum company is one of the most sustainable metals companies in the world. 
Aluminum is a very energy-intense product to manufacture, yet this company produces it with 
a largely renewable energy mix. Its products are used for light-weighting cars and in various 
aerospace applications. Moreover, the company offers certified aluminum and has a long tradi-
tion of reporting on its sustainability efforts. This case presents how environmental, social, and 
governance (ESG) criteria affected our valuation of the company in June 2017.
ESG STRENGTH IN A DIFFICULT SECTOR
The metals and mining sector faces serious ESG headwinds, such as health and safety issues, 
environmental issues, and the management of local stakeholders in politically difficult loca-
tions around the world. Within the sector, aluminum has the additional problem of being 
highly energy intense. Worse still, many producers generate that energy using coal. However, 
this particular company stands out from its peers in several ways. First, its energy consumption 
mix is mostly renewables (with the balance being gas), which means it actually has a positive 
sensitivity to carbon pricing. Second, the company has a strong safety record, resulting in lower 
risk and higher margins. Third, it has been a pioneer in sustainability reporting (starting in 
the 1980s) and in providing certified aluminum, with a transparent supply chain for buyers.
IMPACT ON VALUE DRIVERS—BASE CASE
When we talked to the company’s chief financial officer in 2014, he told us that he identi-
fied a clear correlation at the company’s plants between costs and health and safety. We 
estimated that this saves the company about $150 million per year, which is about a 100 
basis-point (bps) margin. The company’s health and safety profile also lowers the risk of 
disruptive accidents, for which we adjusted the cost of capital by 50 bps. As a result, our 
target price was 17% higher than it would have been without a favorable view on the com-
pany’s sustainability profile (see Figure 1).
Although the company’s superior health and safety record is reflected in higher mar-
gins and lower risk, these factors are not necessarily captured by the market.
IMPACT ON VALUE DRIVERS—CARBON PRICE SCENARIO
Although the company already benefits from its better health and safety record, it does not 
show a clear financial benefit from its renewable energy mix—or at least, not yet. This will

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change, though, if the negative externalities of its competitors (i.e., high pollution from 
coal-based aluminum production) are internalized—by a carbon price, taxation, or other 
regulatory measures (such as forced closures).
We modeled a scenario in which the carbon price goes to €40 in 2022. In such a 
scenario, we expect the company to enjoy a $200-per-ton additional cost advantage 
against its peers, resulting in 200-bps higher margins. Moreover, we expect five years 
of 100-bps higher sales growth as aluminum displaces more steel in light-weighting 
applications. In combination, this gives a 27% higher target price than the base case 
(see Figure 2).
The increase is even greater—34%—when compared to the prevailing market price 
of €54. The carbon benefit impact is large, but it should be interpreted with caution. First, 
this is just one possible scenario. One could disagree on the size and timing of a carbon 
price rise. A lower and later carbon price rise would yield a smaller percentage impact to 
the target price. Conversely, even higher target prices may be obtained if one assumes a 
higher and/or earlier rise in the carbon price. 
FIGURE 1: TARGET PRICE WITH AND WITHOUT AN ESG BENEFIT
WITH ESG BENEFIT 
(BASE CASE)
WITHOUT ESG 
BENEFIT
ADJUSTMENT
$ CHANGE IN 
TARGET PRICE
% CHANGE IN 
TARGET PRICE
WACC—OH&S
9.0%
9.5%
–0.5%
4.7
8%
Margin—OH&S
13%
12%
1%
5.1
9%
Target price
67.1
57.3
…
9.8
17%
Abbreviations: OH&S, occupational health and safety; WACC, weighted average cost of capital.
FIGURE 2: TARGET PRICE WITH AND WITHOUT A CARBON BENEFIT
WITH CARBON 
BENEFIT
WITHOUT  
CARBON BENEFIT 
(BASE CASE)
ADJUSTMENT
CHANGE IN 
TARGET PRICE
% CHANGE IN 
TARGET PRICE
Sales growth in 
5-year window
5%
4%
1%
7.7
11%
Margin
15%
13%
2%
10.5
16%
Target price
85.3
67.1
…
18.2
27%

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FIGURE 3: CARBON PRICE PROBABILITIES AND PRICE PER SHARE
60.0
65.0
70.0
75.0
80.0
85.0
90.0
0%
10%
20%
30%
40%
50%
60%
70%
80%
90% 100%
Price per share  
Probability of the carbon price rise scenario
Scenario-Weighted Target Price
Second, one could attach varying probabilities to such scenarios. Figure 3 plots the 
scenario-weighted target price against the probability of a carbon price scenario (or equiv-
alent) occurring.
For example, if one attaches a 50% probability to this carbon price scenario, one 
arrives at a 76 target price. A zero-percent probability brings us back to the base-case 
target price of 67. 
Third, as such scenarios are admittedly quite simplistic, they should not be taken too 
literally. In this case, the €40 carbon price should not be seen as a point estimate, but as 
the weighted average expected outcome. 
In spite of the noted caveats, scenario analysis is valuable as it provides a good indica-
tion of the sensitivity or impact of events. And it is a great way to discuss the risk–return on 
stocks, even if one disagrees on major assumptions. Too often, analysts model small things 
with high supposed precision (and little valuation impact), while large events that may or 
may not happen are left implicit—until they do occur and turn out to have a much greater 
impact than anticipated.

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OLD MUTUAL INVESTMENT GROUP 
FRAMING THE FUTURE FORTUNES OF  
A GLOBAL DIVERSIFIED MINER USING  
AN ESG ANALYSIS LENS 
Jon Duncan
This case study is framed by the idea that the winners in the future economy will be those 
who can rapidly “decarbonize” their economic growth—the transition to a low-carbon 
economy is now recognized as being imperative. The normative framing of this sustain-
ability issue is founded in the scientific consensus that runaway climate change will have 
massively destabilizing effects on investment markets, societies, and biophysical systems. 
Further support for this normative framing is provided by the now global acceptance that 
addressing environmental, social, and governance (ESG) factors is firmly in scope for 
those acting as fiduciaries. 
For long-term investors, the challenge of portfolio decarbonization in line with the 
requirements of science is a reality. Investors have strategic choices to make over the next 
15 years. These choices could include, but are not limited to, a combination of investments 
in low-carbon indices, the pursuit of growth companies that benefit from a low-carbon 
economy, or investments in carbon-intensive businesses coupled with the aim of chang-
ing behavior through engagement. For emerging-market investors, the challenge is further 
compounded by the fact that some emerging-market countries have economic growth and 
climate policies that allow for the absolute growth of greenhouse gas emissions out to 2030 
through the continued use of fossil fuels. Added to this is the currently sparse low-carbon 
opportunity set in the emerging market–listed equity environment. 
This case study showcases the use of an ESG lens to assess one aspect of a mining com-
pany’s long-term strategy. The approach has relevance in the context of a bottom-up fun-
damental analysis and provides insight into why active company engagement is so critical. 
REVIEWING STRATEGY THROUGH A  
SUSTAINABILITY LENS 
As a diversified global mining and commodity trader, this particular company is a com-
plex business—though when viewed through a sustainability lens, the company’s strategy 
appears relatively simple and focused. The company is playing both sides of the climate 
change story—on the one side, there is a play on unloved thermal coal, and on the other 
side, the focus is on the metals needed for sustainable mobility and mass electrification. 
Whether this strategy is intentional or not is a moot point; the fact is that there are ESG 
risks on either side of this strategy. Elements of these ESG risks are described below.

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Loving Coal 
With respect to coal, the company is betting that between Japan, India, and China, there 
will be buyers of high-grade thermal coal until at least 2030. The company has recently 
acquired coal assets and looks intent on further building up its coal portfolio. Energy 
products (oil and coal) generated as much profit for the company in 2017 as in the previ-
ous three years combined, and accounted for a quarter of the group’s earnings. 
The company’s fossil fuel strategy might be unpopular, but if executed correctly, it 
could be profitable and aligned with a two-degree future scenario. It is potentially a “last 
person standing” game—founded on the idea that the company will be able to produce 
the highest-quality thermal coal as slumping demand knocks out the marginal mining 
pits and keeps coal prices up. The key to successful implementation will be to make sure 
the company does not overpay for coal assets (i.e., it can monetize them within the 2030 
time horizon), has secure long off-take agreements (i.e., it understands who the long-term 
buyers are and has off-take agreements), and has enough cash set aside for full mine reha-
bilitation (or can sell the mines before it gets to that point). 
However, global pressure is mounting for companies to disclose how they will manage 
the transition to a zero-carbon world; the biggest industry initiative is the Financial Stability 
Board’s Task Force on Climate-Related Financial Disclosures (TCFD). The company has 
slowly changed its public narrative with respect to climate change and is now supportive 
of TCFD’s recommendations. Going forward, the company has made a commitment to 
report on the physical, liability, and transition risks associated with climate change and 
the implications for its business. On the face of it, the business appears to be making the 
right gestures; however, it is making many assumptions regarding the future demand for 
coal and the replacement rate of renewables. For example, China’s rate of reduction is hap-
pening faster than anticipated (driven by its 13th five-year plan’s green economy focus). In 
2017, China cancelled over 100 planned or under-construction coal plants. Nevertheless, 
China remains the world’s largest energy consumer, accounting for 23% of global energy 
consumption and contributing 27% to the global energy demand growth (BP Statistical 
Review 2017 – China Energy Market in 2016). Coal remains China’s dominant fuel source, 
accounting for 62% of its energy consumption in 2017 (down from 74% in 2006), with a 
58% target for 2020. Chinese demand will fall, but the coal supply will fall as well. 
Facing Headwinds or Fanning Growth? 
The company will face the headwinds of the financial market’s enhanced awareness of 
the destabilizing risks of runaway climate change, the emergence of economic policies 
that seek to price the externality costs associated with carbon emissions (either by way 
of national tax or cap and trade mechanisms), shifts in public sentiment on climate eth-
ics, disinvestments by large asset owners, rapid declines in renewable energy costs, and an 
accelerating renewable energy penetration (i.e., 50% of installed energy capacity in 2018 
will come from renewables). 
Counterbalancing these challenges is the stark reality that many emerging-market 
economies have climate policies that envision an increase in absolute carbon emissions 
until 2030, followed by a stabilization of emissions, and then a decline through 2050. At

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present, some 80% of global energy is produced from fossil fuels. Although developed 
countries are experiencing sharp declines in their reliance on fossil fuels, many emerging-
market economies will still have a demand for coal. The question for investors is, “Can 
this company responsibly mine coal and deliver the planned-for coal demand in emerging 
markets, while at the same time support the transition to a low-carbon economy?”
CHALLENGES FOR VALUATIONS 
A foreseeable challenge for companies that primarily hold fossil fuel assets is that their 
shares will likely be traded at a discount going forward; as a consequence, shareholders 
should demand enhanced dividends. The idea of reducing coal assets in line with global 
requirements and returning the cash to shareholders may be seen as a potential market-
based approach to transitioning to a zero-carbon world, but both the issuers and holders 
will need government and public support for this to happen. A precursor to this is the 
arduous task for national governments to set carbon budgets and police emissions—both 
of which take time and, in some cases, are being hampered by lobbying activities of big 
businesses with vested interests in the fossil fuel markets. 
As an investor in a company of this nature, incorporating these climate and sustain-
ability considerations into valuation calculations is not an easy task. Currently, part of our 
approach is to use these insights to test assumptions regarding future coal demand, rates 
of renewables replacement, and levels of company transparency and capacity with regard to 
managing climate risk. We use this approach as the basis for building bull- and bear-case 
scenarios. Alongside this, demanding a higher margin of safety, prudently managing capital, 
and seeking high dividends are all important considerations when analyzing a company of 
this type. 
Analyzing the quality of the company’s board is also a crucial step in our approach, 
primarily to ensure it has the requisite skills to oversee the climate dimension of the busi-
ness risk and that there is an appropriate level of transparency with regard to the busi-
ness’s associations and lobbying activities. 
The need for sound corporate governance also extends to the company’s dealings with 
the governments that host its operations. Metals used in the sustainable mobility transi-
tion account for a substantial portion of the company’s core profit—more than double the 
proportion of its major listed competitors. One of the key challenges is that the company’s 
main metal assets are located in jurisdictions that have significant political challenges. The 
risks in this case include the rapidly changing political environment, the historical context 
of how mineral rights were acquired, concerns over the security of future mineral rights, 
and the potential changes to royalty taxes. Navigating these risks will require strong ethi-
cal company leadership and sound governance practices at the board level. Direct engage-
ment with both the company management and board is critical for assessing the quality of 
leadership and robustness of governance practices.

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SUMMARY
The intention of this case study is not to provide a “paint-by-numbers” approach to build-
ing ESG issues into a discounted cash flow; neither is it a business case advocating an 
investment in fossil fuels. Rather, this case study aims to highlight some of nuanced macro-
thematic issues that emerge when looking at a company’s business strategy through an 
ESG lens. We believe this approach is a critical starting point for an analysis of a long-term 
investment that is aligned with the transition to a low-carbon economy.

87
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QUANTUM ADVISORS PRIVATE LTD.
ESG INVESTING IN INDIA: THE INDIAN  
AGROCHEMICALS INDUSTRY
Bhavesh Bajaj
Environmental, social, and governance (ESG) investing is at a nascent stage in India. At 
present, only a handful of asset management companies are considering integrating ESG 
into their investment analysis process. The demand comes from foreign institutional cli-
ents or the foreign partners of asset managers. The biggest challenge for ESG investing 
in India is the lack of data availability, as only about 85 companies in India have pub-
lished their sustainability reports. Of the companies that do provide sustainability reports, 
almost 60% have been released only in the last five years. Companies in India that pub-
lish their sustainability reports follow Global Reporting Initiative (GRI) standards, and 
the Securities Board of Exchange of India has mandated the top 500 companies publish a 
Business Responsibility report.
ESG INTEGRATION AT QUANTUM ADVISORS
At Quantum Advisors, ESG investing is considered a risk-mitigation technique, and we 
have a dedicated ESG research team. An in-house ESG scoring model has been developed 
based on qualitative and quantitative analyses of the companies. We also meet each com-
pany’s management and its chief sustainability officer to gather deeper insights into its 
practices.
Our research process places a great emphasis on corporate governance. In addition to 
the GRI framework, we assess 240 metrics based on company disclosures. We also investi-
gate whether the companies have documented specific policies regarding ESG issues and 
how detailed the policies are (e.g., a privacy policy, a prevention against sexual harassment 
policy, a vendor management policy, and an occupational health and safety policy, among 
others). 
A summary of our ESG evaluation metrics along with the weightings for each category 
is given in Figure 1.
If we find that potential risks to a company’s performance are quantifiable, then we 
adjust future growth rates or attach costs to these probable risks. If the potential risks are 
not quantifiable, especially regarding the timeline of the event occurring, we adjust the 
price multiples for the company. We may choose not to invest in a company if it violates 
regulations and follows unethical governance practices.

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KEY MATERIAL ESG ISSUES IN THE AGROCHEMICAL 
SECTOR
The agrochemical sector is about a $35 billion industry in India. The industry poses 
certain ESG issues such as product stewardship, water consumption and water stress, 
energy consumption, hazardous waste, product labeling, and lack of innovation. 
AGROCHEMICAL SECTOR CASE STUDY
Product Stewardship
The toxicity levels of the agrochemicals are harmful, not only to the laborers in the 
manufacturing process but also to farmers, the soil, and the end consumers. The Central 
Insecticide Board of India has categorized agrochemical toxicity levels based on a labeling 
system—using red, yellow, blue, and green labels—where red is the most toxic and green is 
the least. Most of the red-labeled products are banned abroad but are being sold in India 
due to the lack of a strong regulatory environment.
FIGURE 1: QUANTUM ADVISORS’ ESG EVALUATION METRICS
Corporate Governance
Environmental
Social
WEIGHTING
50%
25%
25%
Key Issues
Board compensation 
structure
Energy consumption
Product stewardship
Related party 
transactions
CO2, NOx, SOx emissions
Health and safety
Litigations
Hazardous waste and 
recycling
Land acquisitions
Forensic accounting
Water consumption and 
recycling
Labor relations
Audit report checks
Baseline water stress
Local community 
management
Board committee 
structure
Biodiversity
Supply chain
Minority shareholder 
treatment
Climate change
Sustainable sourcing
…
…
Data privacy

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© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
In 2012, Company X made a decision to eliminate red-labeled products from its 
portfolio; in 2017, it also discontinued yellow-labeled products. At the other end of the 
spectrum, 14% of Company Y’s top-selling products are derived from red- and yellow-
labeled products.
Impact on Valuation: Initially, Company X’s phasing out of its toxic products nega-
tively affected its revenues by 8%. But as the country’s regulatory landscape evolves 
toward more stringent norms, Company X will be cushioned for regulatory changes and 
thus does not face potential future downsides. Company Y, however, may well face a simi-
lar impact on its revenues as was witnessed for Company X. The timeline of the scenario 
is uncertain, but when the regulatory shift occurs, it will happen in a gradual phase, 
with a time frame of 24 to 36 months. Company Y will have to increase its research and 
development (R&D) spending to safeguard itself from the market shift due to the new 
regulatory norms.
Research and Development
Companies with greater R&D spending are likely to perform better in the long run. Many 
companies measure their R&D performance through an indicator called the “Innovation 
Turnover Index” (revenues derived from new product launches in the past three years). 
Company Y spends the highest percentage of revenues on R&D in the Indian agrochemi-
cal industry (see Figure 2). The average industry R&D spending is 0.8% in India and 
4.1% globally.
Impact on Valuation: As observed, a direct correlation is present between R&D 
spending and the revenue growth of the companies. We can assume a higher revenue 
growth rate for Company Y due to its greater R&D spending and a higher Innovation 
Turnover Index.
FIGURE 2: RESEARCH AND DEVELOPMENT DATA FOR COMPANY X AND COMPANY Y
1.28%
7%
4.70%
1.76%
15%
13.8%
Five-year average R&D 
spending (as a % of 
revenues)
Innovation Turnover 
Index
Five-year CAGR revenue 
growth
Company X
Company Y

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Energy
Company X meets 50% of its energy requirements from renewable sources and has com-
mitted to be compliant to RE100 certification1 in the next five years. Company Y is heavily 
dependent on coal (about 65%), and only 5% of its energy requirements are met through 
renewable sources. 
Impact on Valuation: Company Y may be susceptible to potential carbon taxes and 
will need to increase its capital expenditures to reduce its dependency on coal and shift to 
cleaner energy sources. For Company Y to undergo a change in its fuel consumption mix, 
costs per ton would increase substantially because the current cost of coal in India based 
on its calorific value is INR2.4 per million British thermal units (MBTU) compared to a 
calorific value of INR8/MBTU for natural gas.
Water
Agrochemical companies are highly dependent on water in their manufacturing processes. 
India’s agrochemical companies consume approximately 110 million m3 of water annually. 
Companies X and Y are both striving to become zero liquid discharge companies in all of 
their facilities and have achieved almost 50% of their targets. 
Unfortunately, neither company has disclosed its water intensity (water consumption 
per ton of product manufactured). Thus, we have assessed the companies by measuring 
their water risk based on the water stress and the drought severity of their manufacturing 
locations. Our findings, based on data from the World Resources Institute, suggest that 
Company X’s average baseline water stress and drought severity are 2.96 and 3.73 (out of 5),  
respectively, whereas Company Y’s average baseline water stress and drought severity are 
1.94 and 3.67 (out of 5), respectively.
Impact on Valuation: Both companies are engaged in a capital expenditure phase 
to enhance their water storage and recycling technologies. However, Company X may 
have to invest a greater amount of capital expenditure as a percentage of sales due to 
a higher drought severity score and high baseline water stress of its manufacturing 
plants. 
Hazardous Waste
The regulatory landscape for disposal of hazardous waste and effluent treatments is 
quite stringent in India, and we do not believe that the Indian agrochemical industry 
will undergo shutdowns (as seen in China). Both companies have installed in-house 
effluent treatment plants and dispose of their wastes through government-authorized 
agencies.
Impact on Valuation: We do not see any negative impact on the companies because 
they are compliant with the regulatory norms.
1 A global, collaborative initiative led by The Climate Group in partnership with CDP (formerly the Carbon 
Disclosure Project) where businesses commit to using 100% renewable power.

ESG Investing in India: The Indian Agrochemicals Industry 
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© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
Product Labeling
In India, almost 25% of the total amount of agrochemicals sold are counterfeit products. 
The quality and the efficacy of these counterfeit products differ from the original prod-
ucts, which can lead to reputational damages for the companies. Agrochemical companies 
need to add barcodes or other identifying technologies to their product packaging, to 
allow end-use consumers to check for authenticity. Also, because India is a multilingual 
country, the companies will have to publish the usage instructions in multiple languages.
Impact on Valuation: The companies will have to incur a small expenditure to 
improve their backend systems and provide for all their products a unique labeling system 
that is user friendly and interactive. If the sales of counterfeit products are reduced, the 
industry’s revenues could potentially grow by up to 33%.
CONCLUSION
Both companies follow strong corporate governance standards. However, we find that 
Company X’s disclosures are of a superior quality relative to Company Y. Also, Company X 
has absorbed the impacts of possible future regulatory changes. If Company X increases 
its R&D spending, it is likely to experience higher growth in the future.

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RBC GLOBAL ASSET MANAGEMENT 
CASE STUDY: FUNDAMENTAL MATERIAL 
ESG SCENARIO ANALYSIS
Ben Yeoh
Rather than having separate environmental, social, and governance (ESG) analysts, our 
Global Equities team’s portfolio managers perform and integrate ESG analysis to allow us to 
better fundamentally value and assess stocks, completely integrate ESG information into our 
investment process, and meaningfully engage with the companies in which we are invested. 
We also use multiple sources of ESG information as it represents a plethora of ESG-related 
opinions that require interpreting, and portfolio managers are best placed to filter this 
advice and ascertain how it relates to a company’s business model and valuation. (In our 
experience, the ratings of two major ESG research providers only correlate just over half of 
the time and proxy voting agencies occasionally take opposing views on proxy votes.)
We start with a fundamental analysis to identify any material positive or negative ESG 
factors. We embed that assessment into an analysis of the competitive position and the 
sustainability of the business, which we then put into our valuation models. We invest only 
in companies that perform strongly in all four areas of our model: business model; market 
share opportunity; end-market growth; and management and ESG.
Our Global Equities team identified several ESG risks (contingent liabilities) and 
opportunities (contingent assets) for UnitedHealth (UNH), a leading healthcare insurer 
and healthcare cost management and IT provider managing 5% of US healthcare 
spending.
RISKS
As custodians of the personal and medical details of millions of people, UNH needs to 
keep these data secure: false savings here can have long-term consequences, including reg-
ulatory risks, political risks, and the potential impairment of the company’s social contract 
with customers and wider society.
We challenged management on the risk of privacy data breaches, asking how that 
risk is being managed and what policies are in place to mitigate that risk. Management 
acknowledged that information about their data security was not available on their web-
site, but several management members reassured us about the quality of the policies, train-
ing, and general operation management of data handling and security that are in place. 
Nevertheless, we still modeled a discounted cash flow (DCF) valuation scenario looking at 
the possible impact of privacy data breaches.

Case Study: Fundamental Material ESG Scenario Analysis
93
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
We learned that UNH had a historic stock option accounting problem (backdated 
without disclosure to lower the strike prices for its CEO at the time), which came to light 
in 2006. However, we noted that many other companies, such as Apple, had similar stock 
option accounting problems in the late 1990s to mid-2000s. We also discovered that in 
UNH’s case it led to the start of a complete turnaround in the company’s corporate gover-
nance policies and practices, and determined that the current compensation structure was 
fair and, importantly for us, included a return on capital/equity component.
Our conversations with UNH gave credence to the recent positive reports from two 
proxy voting agencies regarding the company’s governance practices; there do not appear 
to be remaining accounting or management problems that had been indicated in earlier 
analysis.
OPPORTUNITIES
We viewed UNH’s Optum data analytics business, which allows it to create cheaper, bet-
ter healthcare options for businesses, governments, and patients, as a strong competitive 
advantage and an ESG contingent asset. For instance, it identified 150 diabetic patients 
not taking their medication properly, 123 of whom were in Texas, which enabled its client 
to implement location-specific measures utilizing preventive healthcare techniques. Using 
Optum’s data analytics, the state of Maryland discovered clusters of patients with asthma 
in certain streets and buildings, and found that those buildings correlated with cockroach 
infestations, allowing it to successfully prosecute deficient landlords and ultimately raise 
living standards for tenants.
IMPACT ON ANALYSIS
We assessed the materiality of all of this information and assigned a rating for the four 
components of the company’s strengths (business model; market share opportunity; end-
market growth; and management and ESG). We then performed a DCF scenario analy-
sis embedding the material ESG risks and opportunities (Figure 1). We prefer DCF and 
explicit model scenarios for sales, margins, and asset turns because we see them as a more 
accurate method of modeling than an adjustment to a discount rate or terminal value. We 
also perform sum-of-the-parts and standard financial ratio assessments.
The analysis was peer reviewed within our team, and the assumptions were stress-
tested, challenged, and refined before the rating and valuation were confirmed. In our 
peer review, assumptions are flexed in real time to see how further valuation scenarios 
change. These include increasing EBIT margins and sales growth for the upside scenario, 
and for the downside scenario normalizing sales to a lower growth rate (3%) and looking 
at the sales impact over more than one year.

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FIGURE 1: DCF SCENARIO ANALYSIS
Base-case DCF scenario (a cash flow return on investment framework)
44% target company
share price upside
ESG asset scenario (upside scenario): value generated from contingent 
assets through the use of big data analytics.
Assumptions: Sales increased by 1–2% in years 5–10, but with similar EBIT 
margins and asset turns to the base case. Cost of capital remains the same.
+12 percentage point
ESG liability scenario (downside scenario): assuming a data breach occurs 
that impacts the business (sales, margins, asset growth) for a year before 
recovery.
45
35
25
15
5
–5
45
35
25
15
5
–5
Q2
1994
′96
′98
′00
′02
′04
′06
′08
′10
′12
′14
′16
′18
′20
′22
2024
Asset growth (x)
Normalized growth rate
Assumptions: Approximate 7% impact to sales in the year of data breach, with a 
3% impact to EBIT margins, recovering in future years back to 5% sales growth, 
but on EBIT margins 1-2% lower than the base-case forecast. Cost of capital 
remains the same.
−17 percentage point

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© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
SANTANDER ASSET MANAGEMENT 
ESG EQUITY ANALYSIS CASE STUDY 
Luzia Hirata
Santander Asset Management has developed a proprietary environmental, social, and gov-
ernance (ESG) methodology to inform and support our investment decisions regarding 
Brazilian companies that present leading and integrated sustainability business strategies 
and are therefore developing sustainable competitive advantages. Our equity research 
team assesses companies according to this methodology and evaluates companies that are 
considered financially attractive and are potential candidates for our ESG portfolio. The 
fundamental belief of our investment philosophy is that companies that operate under a 
triple bottom-line approach may offer superior financial performance in the long term. 
This means that companies with ESG performance goals incorporated into their corpo-
rate strategies are expected to be the best performers in the long term. 
The research team takes advantage of an internally built historical database and an 
external database of companies (Bloomberg database). Our in-house ESG methodology 
assesses the performance of companies in each sector using the following six factors: 
1.	 product responsibility;
2.	 management and transparency;
3.	 corporate governance;
4.	 environment;
5.	 stakeholders relationship; and
6.	 risk management.
All issues analyzed are based on five principles: materiality, practices, value chain, 
technology and information, and product responsibility. Only the company’s publicly avail-
able information is used to complete our ESG questionnaire.
As a result of this assessment, each company is scored according to its ESG perfor-
mance. We use an ESG score to apply a discount (maximum 10%) or a premium (maxi-
mum 5%) on the target price. This process allows us to integrate ESG scoring to the target 
price, resulting in an ESG target price. Figure 1 provides an example of this assessment.
The ESG target price assessment can be applied to all stocks and is used for all funds 
under management. Santander Asset Management manages a dedicated fund, called the 
Ethical Fund, which invests in listed Brazilian companies with leading and integrated sus-
tainability business strategies that are thus capable of developing sustainable competitive 
advantages. Companies assessed as attractive by our equity research team qualify for the 
Ethical Fund portfolio.
Because of our product responsibility dimension, companies that have operations in 
the alcoholic beverages, tobacco, gambling, nuclear power, pornography, or defense sec-
tors are not automatically excluded from the investment universe. An essential criterion

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evaluates if the company’s product or activity is harmful to human health. This analysis is 
based on the volume/revenues of the products in these sectors. 
In summary, a comprehensive questionnaire created by the Santander Asset 
Management in-house ESG research team constitutes the main information source for 
each company evaluated. A company’s public reports and meetings with corporate exec-
utives, government agency representatives, and stakeholders are additional information 
sources. Any complaint by any stakeholder (such as nongovernmental organizations or 
social movements) is taken into account in our ESG analysis and also discussed and vali-
dated by our Deliberative Board.
FIGURE 1: EXAMPLE OF ESG PERFORMANCE ASSESSMENT
COMPANY
MARKET 
CAPITALIZATION
(USD, MILLIONS)
LAST PRICE
(BRL)
TARGET
UPSIDE (%)
ESG
PREMIUM/
DISCOUNT (%)
ESG
TARGET (BRL)
SECTOR
A
1.936 
18.95 
21.80
15
2.39
22.32
B
1.048 
12.44 
13.00
5
–7.67
12.00
C
6.239 
11.90 
15.00
26
–0.34
14.95
D
574 
 14.20 
20.80
46
–3.91
19.99
Abbreviation: BRL, Brazilian real.

97
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
SBI FUNDS MANAGEMENT PVT. LTD., INDIA 
GANESHA ECOSPHERE LIMITED:  
AN ESG THEMATIC INVESTMENT THAT 
WORKED FOR THE SBI MUTUAL FUND
Ajit Dange, CFA
SBI Mutual Fund analyzed Ganesha Ecosphere Limited (GEL) during the early part of 
2015 when the stock was just coming out of the relative obscurity generally faced by small-
capitalization companies, and its trading volumes were improving to a few million rupees 
per day. It had also just crossed the INR2 billion market capitalization mark, which meant 
it landed on our radar as an actionable idea. 
GEL recycles polyethylene terephthalate (PET) into recycled polyester staple fiber 
(RPSF), which finds application in clothing, technical textile, fiberfill, automotive acces-
sories, and so forth. The manufacturing of polyester staple fiber (PSF) requires ethylene 
(a derivative of crude oil) as its basic raw material. PET itself is made from crude oil, and 
the recycling of PET to make PSF and polyester staple yarn (PSY) typically extends the 
useful economic life of PET by a few more years (from a typical shelf life of 12 months for 
a PET bottle) by creating more durable products such as clothes, blankets, and fiberfill 
for pillows and toys. Using recycled PET to produce PSF/PSY instead of using crude oil 
reportedly saves 3.8 barrels of crude oil per ton of PET recycled, reduces the amount of 
greenhouse gases generated during the manufacturing process, and conserves over 300 
watt-hours of energy per plastic bottle recycled. 
GEL collects the PET waste at its 20-plus collection centers across India and uses its 
network of more than 200 vendors to convert the PET waste to RPSF, PSY, and textur-
ized/twisted yarn at its four processing units in northern India. The collected waste PET 
bottles are compressed, shipped to manufacturing facilities, sorted to remove non-PET 
stuffs, cleaned, chipped into small flakes, and converted into RPSF through high-speed 
extruders in a nonchemical process. The products (fiber/yarn) manufactured by GEL find 
application in manufactured textiles (e.g., t-shirts, body warmers), functional textiles (e.g., 
nonwoven air filter fabric, geo textiles, carpets, car upholstery) and filling (for pillows, 
duvets, toys, etc.).
Air/water pollution, water conservation, and treatment of urban waste have emerged 
as major challenges facing urban India. Convinced that environmental, social, and gover-
nance (ESG)–compliant businesses generate superior long-term returns, we were looking 
to incorporate these themes on the mitigation of environmental challenges into our analy-
ses when we came across GEL as an investment idea. Other companies in this space with 
these underlying themes include VA Tech Wabag Ltd. and Thermax Limited.
GEL’s governance factor score was decent for this small-scale company, which operates 
in an unprofessional environment dominated by unorganized players such as scrap dealers

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and scrap traders. GEL scored over 75% in our ESG-scoring model, placing it in our top-
most rating category of “A.” 
GEL scored high on social parameters. GEL generates indirect employment for scores 
of scrap scavengers and rag pickers, mostly women, who collect the PET waste for the scrap 
dealers. The scrap dealers sell the waste to scrap traders who, in turn, supply color-segre-
gated and compressed bales of PET bottles to recyclers such as GEL. Because most of the 
process from PET bottle collection to baling is manual, and the process of converting the 
materials into PSF is very labor intensive, recyclers such as GEL employ many unskilled 
laborers. The scrap traders require the efforts of 10 workers to produce one ton of baled 
PET bottles. The process involves sorting (which typically employs female workers) and 
baling (pressing the scrap into tight bundles), which normally requires male workers. The 
economic activity undertaken by GEL thus provides livelihoods for people from the eco-
nomically weaker part of society, and predominantly to women, the weakest.
The company scored well on environmental footprints, as it is engaged in the recy-
cling of PET, which otherwise takes more than 100 years to decompose in a landfill. The 
company’s activities save a large landmass (that would have been required otherwise for 
landfills) and eliminates carbon dioxide (CO2). Figure 1 provides data on these savings.
The company’s historical financial performance was good, with a healthy revenue 
growth along with profitability and high return ratios. The company’s revenue and profit 
after tax (PAT) grew at a compound annual growth rate (CAGR) of 29% during the past 
seven years, with a consistently high return on equity of over 15%. Figure 2 provides the sum-
mary financial data of the company as of April 2015, when we first invested in the company.
Although it was evident from the historical financial data that GEL’s earnings growth 
was slowing because its growing size limited the PET bottle collection growth, the benefit 
of operating leverage was already used up, and falling crude oil prices created headwinds 
for the end-product pricing, the valuation was very comfortable at nine times one-year-for-
ward earnings. In addition, we anticipated that the valuation multiples of the stock would 
be re-rated upward due to GEL’s presence in the sustainable investment space, which we 
believed to be the future of investment. Thus, we bought over 7% of the company’s out-
standing equity for eight mutual fund portfolios. Our holdings of the company’s equity 
went up to 7.4% in March 2017, before being reduced to 4.7%. 
FIGURE 1: GEL’S ENVIRONMENTAL FOOTPRINT SAVINGS
2016–17
2015–16
2014–15
2013–14
2012–13
Bottles consumed (billions)
4.52
4.43
3.76
3.35
2.42
Landfill space saved (cubic yards)
602,313
589,802
500,923
445,771
322,353
CO2 elimination (tons)
122,090
119,554
101,538
90,359
65,342

Ganesha Ecosphere Limited: An ESG Thematic Investment That Worked for the SBI Mutual Fund
99
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
GEL’s profit margins did suffer as crude oil prices fell sharply during 2014–2015, 
thereby eroding the pricing pressure of the company’s end product as substitutes pro-
duced from crude oil derivatives became cheaper. However, the company could cushion 
a large part of the pricing pressure though its strong bargaining power with the supply 
chain, tighter cost control, and migration up the value chain. The company could bargain 
with scrap traders to revise the cost of material supplied downward. It improved the cost 
economics through tighter cost control and a move up in the value chain wherein it could 
reduce the discount of its products produced through the recycling route to those pro-
duced from virgin material from 15% to 5%. Through these measures, it grew its revenues 
and PAT at 10% CAGR for the past three financial years (Figure 3). 
The stock generated an excess return of 131% over our holding period (Figure 4). 
We are happy to note that the majority of the stock’s return comes from the positive 
valuation re-rating experienced by the company, from a lowly one-year forward-earnings 
multiple of 9 times to 19 times. We were expecting this re-rating because we anticipated 
that an increased awareness of the importance of ESG challenges would attract the atten-
tion of more investors to companies that are engaged in environmental mitigation and 
social challenges. It was a very happy investment outcome for us. 
FIGURE 2: GEL’S FINANCIAL DATA, 2007–2014
FINANCIAL DATA 
(AMOUNTS IN 
MILLION INR)
2013–14
2012–13
2011–12
2010–11
2009–10
2008–09
2007–08
Net sales
4987.9
4350.5
3852.3
2913.0
1989.0
1353.7
1054.2
EBITDA
563.0
481.9
433.8
363.0
243.0
173.1
123.5
EBITDA margin (%)
11.3
11.1
11.3
12.5
12.2
12.8
11.7
PAT 
245.4
241.2
206.9
180.2
90.0
43.4
37.5
PAT margin (%)
4.9
5.5
5.4
6.2
4.5
3.2
3.6
EPS 
16.7
15.5
14.1
13.0
8.5
4.4
3.6
ROE (%)
20.36
23.37
25.11
30.62
22.34
15.72
16.78
ROCE (%)
11.88
19.29
17.84
18.80
16.50
12.20
11.70
Abbreviations: EBITDA, earnings before interest, taxes, depreciation, and amortization; EPS, earnings per 
share; PAT, profit after tax; ROCE, return on capital employed; ROE, return on equity.

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FIGURE 4: GEL’S (GNPL) PRICE CHART AND COMPARATIVE RETURNS
FIGURE 3: GEL’S FINANCIAL DATA, 2014–2017
FINANCIAL DATA (AMOUNTS IN MILLION INR)
2016-17 
2015-16
2014–15
Net sales
6725.2
6464.9
6219.5
EBITDA
815.2
752.9
646.8
EBITDA margin (%)
12.1
11.6
10.4
PAT 
299.4
248.6
230.7
PAT margin (%)
4.5
3.8
3.7
EPS 
15.6
12.8
13.4
ROE (%)
13.00
11.63
13.92
ROCE (%)
16.05
14.95
12.01

FIXED-INCOME  
CASE STUDIES:  
CORPORATE BONDS

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BRECKINRIDGE CAPITAL ADVISORS
INTEGRATING ESG FACTORS INTO 
CORPORATE FIXED-INCOME INVESTMENTS
Robert Fernandez, CFA
Breckinridge Capital Advisors is a separate-account, investment-grade fixed-income manager 
based in Boston with over $36 billion in assets under management.1 We serve institutional 
as well as individual clients by offering taxable and tax-efficient US dollar–dominated bond 
strategies. Our primary objectives for our clients are to: (1) preserve capital while building a 
reliable source of income, and (2) take advantage of opportunities to improve total return.
Breckinridge seeks to be vigilant in an ever-changing investment landscape. This 
attentiveness extends to credit risk, as we are committed to carrying out rigorous fun-
damental research on our borrowers. For investment-grade companies, environmental, 
social, and governance (ESG) risks may be low-probability but high-impact factors, as illus-
trated by the governance failures during the financial crisis and by other headlines stem-
ming from corporate environmental or social controversies. 
Therefore, we strongly believe that material ESG issues, when poorly managed, can mani-
fest themselves as a credit risk. With this in mind, in 2011 we integrated an analysis of ESG issues 
into our fundamental credit-research process for corporations as well as for US municipalities.
THE BRECKINRIDGE ESG INTEGRATION PROCESS
When analyzing a corporate bond for investment, Breckinridge analysts first evaluate an issu-
er’s business profile, market position, and competitive profile, as well as fundamental credit 
measures (such as margins, leverage, and cash flow). The analysis then turns to an evalua-
tion of management and sector-specific material ESG indicators, such as carbon emissions, 
workplace injury rates, and the composition of the board of directors. Further, important 
takeaways from any engagement calls with the issuing company are integrated into the analy-
sis. The research is captured in an overall credit recommendation that includes an internal 
rating, a sustainability rating, and the analyst’s bond valuation view. The recommendation is 
distributed to the investment team and helps to drive security selection (Figure 1). 
Our ESG analysis consists of a quantitative score and qualitative-based research. 
The quantitative score is derived from a proprietary framework that aggregates metrics 
from ESG research providers as well as from other third-party sources. Our corporate 
analysts also perform a qualitative assessment by reviewing a company’s ESG policies and 
targets, which may be outlined in its corporate sustainability report or on its website, and 
consider information learned from the engagement call. The analyst evaluates both the 
score and qualitative research when assigning a sustainability rating for the company. 
This measure of an issuer’s ESG risk profile may affect the analyst’s overall internal rat-
ing. Specifically, the analyst may upgrade the internal rating to reflect a corporation’s low 
1 As of 30 June 2018.

Integrating ESG Factors into Corporate Fixed-Income Investments
103
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
ESG risks or downgrade the rating if the ESG risks are considered high or poorly man-
aged (Figure 2). The final internal rating guides our valuation and trading decisions.
Importantly, Breckinridge’s ESG research emphasizes criteria that are material to the 
financial performance of each industry and company. Data show that the most effective 
ESG assessments target material ESG issues that can significantly impact core business driv-
ers for a given company or sector. Firms with stronger performance on material ESG issues 
tend to outperform their peers, according to a 2015 academic study.2 To help determine 
materiality, analysts consider the standards developed by the Sustainability Accounting 
Standards Board, an independent, private-sector standards-setting organization.
2 “Corporate Sustainability: First Evidence on Materiality” by Harvard Business School researchers Mozaffar 
Khan, George Serafeim, and Aaron Yoon, 2015.
FIGURE 1: HOW ESG IS INTEGRATED INTO BRECKINRIDGE’S CREDIT RESEARCH PROCESS
FUNDAMENTAL
CREDIT RESEARCH
PROPRIETARY SCORES,
RATINGS & VALUATION
SECURITY
SELECTION
ESG ANALYSIS &
ENGAGEMENT
FIGURE 2:  CREDIT UPGRADE/DOWNGRADE FOR ESG RISKS
HIGH
ESG
RISKS
A
Company A:
ESG Upgrade
Company B:
ESG Downgrade
BBB+
Internal Rating
A
LOW
ESG
RISKS

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ANALYZING A SOFT DRINK COMPANY
To illustrate the Breckinridge ESG research process, we highlight how a corporate credit 
analyst may evaluate Beverage Brands, a manufacturer of packaged soft drinks.3 Figure 3
summarizes the analyst’s research on the company’s ESG performance across the value chain, 
from how it works with its suppliers to its own operations and the quality and use of its products.
FIGURE 3:  BEVERAGE BRANDS’ STRENGTHS AND CHALLENGES UNCOVERED THROUGH  
ESG RESEARCH
Supply Chain
(Upstream)
Company Operations
(Manufacturing)
Use and Disposal
(Downstream)
E
S
G
Strength:
Collaboration with 
suppliers to improve water 
efficiency by 15% in 
high-risk areas
Strength: 
Comprehensive human 
rights and supplier 
code-of-conduct protocols
Strength: 
Robust antibribery policies 
governing interactions with 
suppliers
Strength: 
Aligned greenhouse gas 
emissions reduction goal 
with Science Based Target 
Initiative*
Challenge: 
Certain talent retention and 
recruitment strategies trail 
best practices
Strength: 
Board of directors formally 
oversees sustainability 
initiatives
Challenge:
Weak disclosure on 
progress being made to 
reduce packaging waste
Challenge: 
Products are primarily sugary 
drinks, despite introduction of 
healthier brands
Strength: 
Rigorous, year-round 
stakeholder engagement 
includes consumer groups
Beverage Brands
Notes: Gray boxes denote material sector issues.
* The Science Based Targets Initiative is a collaboration between CDP, World Resources Institute, the World 
Wide Fund for Nature, and the United Nations Global Compact. To date, 417 companies have committed 
to science-based targets that align with the emissions reductions necessary to maintain global temperature 
increase below two degrees Celsius per the Paris Agreement.
3 Beverage Brands is a fictional name used to maintain anonymity, but the example is of an actual company.

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The research identifies several strengths and challenges, some of which may be mate-
rial from a financial perspective. For example, because water is a key input for the ingre-
dients used in the beverage products, efforts to ensure a steady supply of water would be 
considered both an ESG strength and a credit strength. Furthermore, water management 
is a material issue for the sector, because a lack of water can impact crop yields and prices, 
increasing the cost of goods sold. 
The analyst weighs the strengths and challenges, and compares the performance of 
Beverage Brands to its industry peers. The mosaic of information as provided in Figure 3 
depicts a company with what we believe to be a strong ESG profile, reflecting the various 
initiatives management has put in place to address Beverage Brands’ ESG issues, includ-
ing those that are considered material to the company and sector. A sustainability rating 
is assigned commensurate with Beverage Brands’ solid ESG performance, which is also 
incorporated into its internal rating. 
When appropriate, Breckinridge analysts may adjust their financial models to account 
for an ESG consideration. In the case of Beverage Brands, the analyst’s projections reflect 
the company’s push into healthier noncarbonated drinks in response to consumer demand 
trends.
CONCLUSION
As an investment-grade fixed-income manager, Breckinridge’s ESG analysis integration 
was a natural evolution of our credit research process. We look at ESG as another tool in 
the credit research toolbox, and use it to gain a better understanding of the quality and 
character of a corporate bond issuer. In the end, we view ESG integration as providing a 
broader risk assessment and simply as a means to prudent investing.

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HERMES INVESTMENT MANAGEMENT
CREDIT PERSPECTIVES: ESG INTEGRATION 
IN PRACTICE—PETRÓLEOS MEXICANOS
Mitch Reznick, CFA, and Audra Stundziaite 
A plethora of academic and financial studies shows a relationship between environmen-
tal, social, and governance (ESG) risk and financial outcomes.1 Well-governed companies 
with minimal or positive impacts on society and the environment tend to have lower costs 
of capital than their less-sustainable peers.2 This has an important implication for credit 
investors: companies with poor ESG characteristics tend to have a higher cost of capital 
because they are exposed to more risks stemming from externalities that undermine cor-
porate financial performance (e.g., fines for not complying with environmental and safety 
regulations).
In addition to analyzing and pricing operating and financial risks, the Hermes 
Investment Management Credit team also considers ESG factors when making investment 
decisions (see Figure 1). To make the best-informed ESG decisions, Hermes Credit relies on 
several inputs: 
■
■
First, from a more general perspective, the Credit team (along with the rest of 
Hermes) relies on the Responsibility team for firm policies, approaches, and 
investment tools. 
■
■
When focusing on an investment at a company-specific level, the team reviews 
Hermes’s proprietary measures of ESG risk, that is, its quantitative ESG (QESG) 
score. This QESG score represents a good snapshot of the company’s overall ESG 
performance. 
■
■
The QESG score is supported by the company information provided by Hermes’s 
engagement team, Hermes Equity Ownership Services (EOS), because the dia-
logue with the company provides the context for the QESG score. For example, is 
the company on the right trajectory or is it more on a negative path?
1 See, for example, Rob Bauer and Daniel Hann, Corporate Environmental Management and Credit Risk (ECCE 
Working Paper, University Maastricht, The European Centre for Corporate Engagement, 2010); Allen 
Goss and Gordon S. Roberts, “The Impact of Corporate Social Responsibility on the Cost of Bank Loans,” 
Journal of Banking and Finance, 35 (2011), 1794–1810; Najah Attig, Sadok El Ghoul, Omrane Guedhami, and 
Jungwon Suh, “Corporate Social Responsibility and Credit Ratings,” Journal of Business Ethics, 117 (2013), 
679–94; Sudheer Chava, “Environmental Externalities and Cost of Capital,” Management Science, 60(9) (2014), 
2223–47; Pornsit Jiraporn, Napatsorn Jiraporn, Adisak Boeprasert, and Kiyoung Chang, “Does Corporate 
Social Responsibility (CSR) Improve Credit Ratings? Evidence from Geographic Identification.” Financial 
Management, 43(3) (2014), 505–31.
2 Gordon L. Clark, Andreas Feiner, and Michael Viehs. From the Stockholder to the Stakeholder (Research Paper, 
University of Oxford and Arabesque Partners, 2015).

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■
Mapping out credit spreads versus their implied spread levels from the QESG 
scores allows us to see where any anomalies exist. In some cases, there may not 
be a trade to make because the credit risk dominates the outright spread level 
compared to the QESG score. That said, in some cases, if we think that the 
ESG behaviors are likely to improve because of conversations we have had with 
the company, it may be a signal to add risk in that particular name. In addi-
tion, if we have to choose between two companies and they are like-for-like in 
terms of credit risk and in credit spread, then the QESG score could signal 
which name we would prefer to add to the portfolios.
With all this information, the ESG contribution to the investment decision is made in 
a more real-time and more dynamic manner than, for example, simply relying on scores 
alone. More importantly, because we engage as an investor, companies are more likely to 
be responsive.
FIGURE 1: HERMES CREDIT’S INVESTMENT APPROACH
EOS
Engagement
specialists
QESG Scores
Proprietary
quantitative ESG
scores
Responsibility
Sets ESG policies
and consults with
investment teams on
ESG integration1
Hermes
Credit
Source: Hermes Credit.

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ESG INTEGRATION IN PRACTICE: 
THE CASE OF PETRÓLEOS MEXICANOS
Petróleos Mexicanos (Pemex) is a Mexican state-owned petroleum company. Founded in 
1938, it is the eighth largest oil producer in the world, with production of approximately 
two million barrels of oil a day and revenue of about US$62 billion. Although Pemex is 
wholly owned by the Mexican state, the company has a strong presence in international 
debt capital markets on which it relies to finance its operations, with around US$87 billion 
of debt outstanding.
In February 2017, Hermes Credit invested in Pemex’s new, euro-denominated issue 
to increase our exposure to the energy sector at an attractive relative value for a higher- 
quality, investment-grade energy credit. An in-depth analysis of the company’s credit gave 
us a better understanding of the company’s oil reserves, production levels, and recent 
operational initiatives, as well as the implications of Mexico’s energy reforms.
During our analysis, however, ESG factors emerged as recurring themes in the credit 
discussion: the company’s labor safety track record was below the industry average and the 
company had experienced frequent oil spills and leaks in the past. Spills and leaks could 
result in fines and production downtime, hurting the company’s cash flow profile. For 
example, BP plc had to pay a US$13.8 billion fine after its Deepwater Horizon well blowout 
in the Gulf of Mexico. Employee injuries could also result in fines.
After the initial credit committee analysis, we assigned an ESG score of 4 (below aver-
age on a scale of 1 to 5, with 1 being the best) to Pemex and decided to address our con-
cerns through an ESG-focused engagement with the company. We kept the bonds acquired 
through the new issue process, but we did not add more exposure to the credit until we could 
speak to the company about our ESG concerns, despite relatively attractive bond valuations. 
During our initial engagement call in May 2017, the Pemex sustainability and inves-
tor relations teams addressed some of our concerns. The company commented that it is 
very committed to improving labor safety and environmental management through such 
initiatives as a zero-tolerance campaign regarding safety, as well as a commitment to reduc-
ing carbon emissions by 25% by 2021. We discussed how the company plans to achieve 
this emissions target, and the teams described initiatives to reduce flaring, implement 
the cogeneration of energy in various industrial facilities, and initiate energy efficiency 
improvements in refineries.
The Pemex management also highlighted that a newly established oil and gas safety 
agency in Mexico is aiming to bring to Mexico all the best international practices, such as 
adoption of and compliance with international technical standards. We expect Mexico’s 
new regulatory framework, along with the independent external health and safety regula-
tions, to have a positive impact on the company, as it will be more exposed to best practices 
used by competitors and partners.
In November 2017, we upgraded Pemex’s ESG score to 3 (from 4) to reflect the com-
pany’s improvement in the following ESG factors: (1) improvement in worker safety (injury 
frequency per million man-hours worked declined 35% year over year [y/y] in the third 
quarter of 2017); and (2) progress in reducing environmental waste and emissions (water 
reuse increased 66% y/y, while sulfur oxide emissions declined 45% y/y). After the score

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upgrade, we have added to our Pemex bond position because we felt more comfortable 
about the company’s ability to manage ESG risks, assuming that the credit profile remains 
stable and that valuations are adequate. 
Through 2017, Pemex bonds tightened around 80 basis points, thus outperforming 
the Global Investment Grade Energy Index by some 45 basis points (see Figure 2). Note 
the following important dates related to the Pemex investment.
Important Dates Related to the Pemex Investment
 
■
February 2017: Addition to the portfolios via new issue in order to add exposure 
to energy. 
 
■
April 2017: Initiation, ESG score 4 (on a scale of 1 to 5 with 5 being the worst).
 
■
May 2017: Commencement of engagement with company’s Safety and Environment 
team.
■ 
November 2017: Upgrade ESG score to 3 (from 4) to reflect
o improvement in worker safety (injury frequency per million man-hours worked 
declined 35% y/y in Q3 2017); and
o progress in reducing environmental waste and emissions (water reuse increased 
66% y/y; sulfur oxide emissions decreased 45% y/y).
 
■
May 2018: Company updates regarding ESG include
o new compliance program; and
o reduced government ability to influence the makeup of the company’s board.
FIGURE 2: PEMEX VERSUS GLOBAL INVESTMENT GRADE ENERGY INDEX
Feb 17
140
180
220
260
300
340
Apr 17
Global Credit - Energy - OAS
PEMEX 6.875 08/04/2026 OAS
Jun 17
Aug 17
Oct 17
Dec 17
Feb 18
Apr 18
Source: Barclays Live - Chart.

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INSIGHT INVESTMENT
HOW TO INVEST RESPONSIBLY  
IN CORPORATE DEBT
Joshua Kendall
Some investors use the terms “responsible investment” and “ESG” (referring to environ-
mental, social, and governance factors) interchangeably. At Insight Investment, we believe 
that responsible investment refers to a much broader approach than simply one that 
focuses on ESG issues—though ESG factors have a key role to play.
We believe a responsible approach to investing in corporate debt depends on the 
effective management of the risks and opportunities presented by long-term value drivers, 
including ESG issues. Below, we outline how such a strategy works in practice. We believe 
the full integration of ESG risk factors within investment analysis and proactive engage-
ment on material issues are crucial aspects of this strategy.
INTEGRATING ESG FACTORS WITHIN  
INVESTMENT ANALYSIS
The first step in establishing a responsible investment approach is to ensure the investment 
process takes into account all material risks, including ESG factors. At Insight, default risk 
is the prism through which our corporate bond analysts consider every issue, and ESG 
risk scores are a necessary element in assigning a credit rating that indicates the relative  
risk of default loss. Insight’s credit analysis team is charged with determining the material-
ity of issues on our risk checklist (see Figure 1).
By combining ESG risk screening and financial analysis in our extended credit risk 
appraisal process, we bring together an assessment of the financial risks associated with 
a company’s performance with a clearly defined set of key business risks as a part of the 
mainstream investment process.
Doing this matters. In 2017, one of our analysts identified material risks at a global 
retailer and recommended avoiding a new issue from the company. Within months, sig-
nificant accounting irregularities emerged, the company was downgraded, and the invest-
ment swiftly lost approximately half its value.
IDENTIFYING ESG RISKS
We transpose third-party ESG ratings into the five-point risk scale that we use to assess 
the significance of nonfinancial risk factors. Our ESG assessment focuses on the material 
risks in each sector or business. For example, we consider carbon emissions and health and

How to Invest Responsibly in Corporate Debt 
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safety as important risks for companies operating in the mining sector, but we see these 
as generally of lower importance for financial services companies. The exception is with 
corporate governance, where we consider the risks an important part of our evaluation for 
every type of issuer and credit quality. Figure 2 illustrates the range of ESG risk issues and 
the scores we use.
FILLING THE GAP
Data from third-party providers are important, but not enough. For many smaller  issuers—
especially emerging-market and high-yield companies—the availability of relevant nonfi-
nancial data often lags behind that available for larger issuers.
Insight, therefore, follows a process to generate ESG ratings for those companies for 
which we cannot source independent ESG analysis from our market data providers.
1. Insight credit analysts identify companies with no ESG ratings but where the company 
is, or may be, issuing bonds that may be suitable for Insight’s credit portfolios.
2. Insight credit analysts work with the Insight ESG analyst to develop a custom ESG 
self-assessment tool that reflects the sector-specific risk issues relevant to the 
issuer.
3. Company management is contacted to complete the self-assessment.
4. Insight generates an ESG scorecard based on the self-assessment response.
5. Insight credit analysts follow up with any risk issues identified.
FIGURE 1: INSIGHT INVESTMENT’S RISK CHECKLIST
1–5 
rating
•  Assuming no access to capital markets in the next 24 months, what is
    the impact on the issuer’s liquidity?
Liquidity
•  What is the magnitude of the issuer’s off-balance-sheet liabilities such 
    as pension deficits, operating leases, acquisition earn-outs, etc.?
Contingent liabilities
•  To what extent is the issuer’s industry subject to regulation and 
    changes in regulation?
Regulatory risk
•  Is the issuer properly managing environmental, social, and 
    governance risks?
Environmental, social, 
and governance (ESG)
•  Does the issuer have an appetite for debt-financed M&A? Does a 
    weak share price pressurize management?
Event risk
•  Could the issuer be subject to an approach from private equity or an 
    activist shareholder? 
LBO/Activist risk
ESG Risk Assessment—Internal and External Analysis
Buy
Hold
Sell
Bond 
value
Materiality Assessment: Is the Risk in the Price?
Source: Insight Investment. For illustrative purposes only.

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EXAMPLES OF ANALYST RECOMMENDATIONS 
INFLUENCED BY ESG FACTORS
Our analysts’ views on ESG factors have directly affected their investment recommenda-
tions, as demonstrated by these two recent examples. Note that low ESG scores do not 
automatically result in an exclusion or sell decision.
Example: Long Position
European property company:
■
improving governance outlook
■
successful engagement with company on ESG issues
Analyst recommendation: Overweight exposure in active portfolios.
Example: Short Position
US technology company:
■
low ESG ratings, especially for governance
■
faces industry headwinds
■
slow to respond to emerging trends
Analyst recommendation: Sell via credit default swaps; not suitable for holding to maturity.
FIGURE 2: INSIGHT INVESTMENT’S ESG RATINGS FRAMEWORK
Environment Pillar
Absolute score 1–5
Carbon
Natural 
Capital
Pollution
Social Pillar
Absolute score 1–5 
People
Products
Responsible 
investment
Health and 
demographic
risk
Place
Governance Pillar
Absolute score 1–5 
Corporate 
Governance
Behavior
Carbon
emissions
Water 
stress
Toxic 
emissions
Labor 
management
Product safety 
and quality
Controversial 
sourcing
Board
Business 
ethics
Carbon 
vulnerability
Biodiversity and 
land use
Waste
Health and 
safety
Chemical safety
Pay
Anticompetitive 
practices
Product 
footprint
Raw material 
sourcing
Human capital 
development
Financial
product 
safety
Ownership
Corruption and 
instability
Financing
Supply 
chain
Privacy and data 
security
Accounting
Financial system 
instability
ESG Overall Score
Normalized industry-adjusted score 1–5
Tax 
transparency
Ratings 
used in 
Risk 
Checklist
ESG issues
Assessed category for all issuers
Source: Insight Investment and MSCI Inc. For illustrative purposes only. Based on MSCI ESG ratings framework.

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ENGAGEMENT: A KEY ELEMENT OF 
A RESPONSIBLE APPROACH TO CREDIT
If ESG, strategic, and financial risks are identified, our analysts are expected to engage in 
a dialogue with company management. Material governance issues are regularly discussed, 
and material environmental and social issues are covered when relevant, as we consider 
ESG risks alongside other factors when assessing a company’s financial strength, strategic 
direction, and overall quality of management, and the market valuation of its securities. 
We also monitor changes—particularly downgrades—to key risk scores each quarter.
Insight’s credit analysts meet with all companies before investing in any bonds or loans 
the companies have issued or are about to issue. Company meetings are undertaken by our 
in-house analysts because we consider engagement to have material financial implications, 
and we believe that those implications are best understood within the context of the wider 
investment process.
Escalating engagement activities occur on a case-by-case basis. From a risk perspec-
tive, if we are not satisfied with a company’s management of risk (including ESG-related 
risks), we are prepared to sell holdings or move to an underweight position. In some port-
folios, this will not be possible because of mandated restrictions. In such situations, we dis-
cuss potential investment actions with clients (which may include taking no action, selling 
holdings, or continuing to monitor).
Engagement can have a clear impact on an investment. We extensively consulted with 
a major listed company in 2017 to improve its disclosures in its accounts. It agreed and 
committed to improve its disclosures in the future, and we subsequently invested in that 
company’s issue.
CONCLUSION
We believe a responsible approach to investing in corporate debt is to integrate ESG risk 
factors within the investment analysis to ensure that all material risk factors are taken into 
account. To do this effectively, proprietary research is often needed, especially in areas of 
the market not covered by third-party data providers.
Integrating ESG risk factors can do more than simply lead to exclusions from the 
investment universe. It can provide more information on the risks within a portfolio and 
prompt effective engagement to help manage such risks or even improve the prospects for 
potential investments.
Ultimately, we believe following such an approach supports long-term investment out-
comes and aligns our interests with those of our clients, as well as the wider society.

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MAN GLG
CREDIT RISK CASE STUDY: AGROKOR
Danilo Rippa
Agrokor is a Croatian holding company whose main business is food retailing. At its peak 
in 2017, it comprised 143 companies with 57,000 employees and was the largest privately 
owned company in Croatia and in all of the western Balkans.
The company was founded as a flower grower in 1976 by Ivica Todorić. Agrokor rap-
idly expanded over the next 40 years until it became insolvent in 2017. The company’s 
downfall was accelerated by its 2014 purchase of Mercator, a retailer from Slovenia, in a 
debt-financed acquisition that significantly impacted its financial flexibility going forward. 
At the time, this consequence was not completely apparent, because Moody’s Investors 
Service affirmed Agrokor’s B2 rating post the acquisition.
ENVIRONMENTAL, SOCIAL, AND GOVERNANCE  
FACTORS THAT DROVE THE INVESTMENT DECISION
Man GLG’s discretionary credit funds were either outright short or had underweighted 
Agrokor risk. Our negative view was reached after our bottom-up credit research found 
inconsistencies between Agrokor’s financial presentations and its detailed financial 
accounts and accompanying footnotes. For example, despite the company highlighting 
stable-to-deleveraging credit metrics and positive free cash flow, the audited financial 
statements revealed a business that was free cash flow negative with net debt increas-
ing beyond what could be explained by payments for acquisitions. These discrepancies 
raised the question of which set of numbers the market could trust and what level of 
corporate governance would allow two separate sets of financials to reach the market. 
In addition, the company’s long history of growth by acquisition made us uncomfortable 
because the company kept changing its reporting perimeter, thereby, in our opinion, 
obfuscating the ability to reconcile financial statements with prior-period reports and 
contributing to the use on the presentations of pro forma figures instead of those from 
the audited financial statements. Additionally, our discretionary fixed-income funds gen-
erally view serial acquirers with some skepticism given the significant execution risks 
associated with integrating acquired companies.
Governance is one of the most important factors to evaluate when investing in fixed-
income securities. Bondholders are looking to be repaid in full, and poor governance 
can easily jeopardize a company’s financial health, precipitating a rapid decline in the 
market price of the bonds and potentially impacting the final maturity and recovery 
value of the notes.
Governance is also notoriously hard to score on an absolute basis or to model into 
traditional forward-looking credit metrics. We tend to use a red-flag system where bond

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FIGURE 1: AGROKOR BOND (9.875% OF 05/19) PRICE CHART (AGROK-XS0776111188)
0
20
May 13
May 15
May 16
Aug 13
Nov 13
Nov 14
Nov 15
Nov 16
Feb 14
Feb 15
Feb 16
May 14
Aug 14
Aug 15
Aug 16
May 17
Nov 17
Feb 17
May 18
Feb 18
Aug 17
40
60
80
100
120
Price in Euros
Agrokor Bond Price: 9.875% (05/2019)
Source: Bloomberg.
issuers that are flagged with poor governance are avoided. Rather than completely score 
every company we analyze across the full suite of environmental, social, and governance 
(ESG) metrics, we flag companies that exhibit a potential ESG concern for further investi-
gation to determine how severe the downside risk could be. Given that many of our funds 
can take short risk exposures, our investigation centers on whether or not the concern 
is reflected in the bond’s price or if it could send the price significantly lower. Agrokor’s 
history of serial acquisitions involving limited industrial logic, combined with the poor 
accounting transparency, raised a red flag for us.
MARKET IMPLICATIONS
On 2 January 2017, Moody’s downgraded Agrokor’s rating to B3 from B2, reflecting the 
view that the company would not be able to restore its credit ratios in line with the require-
ments necessary to maintain a B2 rating. Moody’s also made comments regarding the com-
pany’s poor financial transparency. Following this downgrade, the company announced 
that it had pulled the proposed syndication of a term loan as a result of poor pricing 
terms. This news sent Agrokor’s bonds down about 5 to 10 points, eventually finding a 
floor at around €86.
Despite Agrokor saying that it didn’t need any additional financing, its debt continued 
to drop on rumors of unpaid electrical and supplier bills and rental payments (Figure 1). 
In mid-February 2017, Agrokor management attempted to calm investors’ fears by saying 
that the company was in a position to sell some of its most valuable assets. 
On 17 March 2017, as discussions of an Agrokor debt restructuring picked up, 
Bloomberg reported that Yuri Soloviev, first deputy president and chair of the Management

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Board of VTB Bank (one of Agrokor’s largest creditors), commented that Agrokor had 
been reporting irregularities “over a fairly long period of time.”
At this point, things deteriorated rapidly for the company. The Croatian government 
eventually stepped in to effectively take control of Agrokor, and PricewaterhouseCoopers 
LLP was ordered to do a full audit, the results of which were announced in a press confer-
ence and reported by Reuters. At the press conference in October 2017, Ante Ramljak, the 
government-appointed Extraordinary Commissioner for Agrokor, revealed that Agrokor 
had misstated its financial statements by billions of kuna. 
KEY TAKEAWAYS
The Agrokor case illustrates the importance of using ESG analysis in fixed-income invest-
ing. Environmental and social issues generally are seen as having a less quantifiable and 
immediate effect on a company’s profitability and can be more difficult to include in 
traditional credit analysis. Governance issues, however, can manifest in the form of poor 
merger-and-acquisition decisions or questionable accounting practices, which have an 
immediate impact on the creditworthiness of an issuer. For Agrokor, it was less the change 
in specific traditional credit metrics that gave us pause and more the overall governance 
and strategic issues with the company. If the company had been clear concerning the stra-
tegic rationale of its expansion and had been consistent in its financial projections, we 
potentially could have become comfortable with the company’s bonds at the right price. 
However, when a company’s financial information and accounting practices are called into 
question, it makes it difficult to be comfortable with an investment. Situations like this 
remind bondholders of the tremendous downside that can arise when a company’s gover-
nance is called into question.

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PIMCO
INTEGRATING ESG IN CORPORATE  
CREDIT RESEARCH
Del Anderson, CFA
PIMCO’s environmental, social, and governance (ESG) process for corporate credit 
emphasizes rigorous analysis of secular trends that are at the core of both global sustain-
ability and long-term asset returns. In recent years, PIMCO has developed a platform that 
supports ESG-focused investment solutions and has enhanced its credit research process 
to incorporate a robust ESG assessment that complements the traditional ratings assigned 
by PIMCO’s team of more than 60 credit research analysts. 
Using industry-specific ESG frameworks, PIMCO analysts review their companies’ 
ESG performance based on information that may be available in public filings and recent 
ESG news and controversies, and through regular engagement with company management 
teams to assign ESG scores. Direct bondholder engagement is critical to understanding 
the risk and reward profile of the issuer and ultimately making an investment decision. 
Our analysts dedicate a significant portion of their time meeting with senior management 
of issuers. They discuss strictly financial matters as well as issues that may relate to respon-
sible business practices, such as how business strategy addresses climate change risks. 
Information from this engagement process often affects an issuer’s ESG score, raising or 
lowering it. 
PIMCO’s resulting ESG assessments are proprietary and distinct from those provided 
by ESG rating providers, with scores that distinguish “Leading Practice” issuers from those 
that raise “Significant Concerns” (see Figure 1). PIMCO’s credit analysts further under-
take an assessment of the “ESG Trend” to determine whether the company is improving or 
deteriorating.
PIMCO ESG RESEARCH IN PRACTICE:  
GLOBAL COMMERCIAL BANKS
The approach outlined above can be illustrated by focusing on how PIMCO analyzes ESG 
criteria for global commercial banks. Many investors feel the banking industry’s reputa-
tion has been tarnished by high-profile breakdowns in governance and breaches of pub-
lic trust. At PIMCO, we conduct a forward-looking ESG assessment to identify banks that 
performed well through the financial crisis, or banks that have revamped their manage-
ment teams and governance processes. We view the much stronger regulatory framework 
and elevated stature of risk management as significant credit positives. Although many of

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the changes have been mandated by regulators, leading banks have fully internalized the 
new rules and have invested heavily in redefining their culture and the conduct of their 
employees.
Comparing Global Banks across Material ESG Factors
PIMCO’s ESG assessment for banks includes 11 material factors, including “Sustainable 
Lending,” “Systemic Importance/Regulatory Environment,” and “Culture/Business 
Conduct.” Together, these factors comprise PIMCO’s overall ESG score, which has a greater 
weighting on governance (60%) and social (25%) factors than on environmental (15%) 
issues. Figure 2 shows a summary that provides portfolio managers with high-level insights 
into the key ESG strengths and weaknesses of major banking systems. 
Environmental (15% of PIMCO ESG Score)
 
■
Sustainable lending impact is broader than simply looking at the percentage of 
loans issued to industries with negative environmental impacts. We also look at 
underwriting trends, including whether the bank is reducing lending to the coal 
sector and expanding lending for renewables, and whether the bank is involved in 
controversial projects.
 
■
The environmental and sustainability plan assessment includes a discussion of 
credit risk to the loan portfolio from climate change. The highest-scoring banks 
have disclosed detailed sustainability targets and made public commitments to 
reduce greenhouse gas emissions. Extra credit is provided for banks that have 
explicitly mapped their revenues to sustainable development goals. 
 
■
Green bond issuance gives credit to banks that have been active in issuing “green 
bonds” (instruments that fund projects with positive environmental benefits)—
either as a part of their own funding or on behalf of clients.
FIGURE 1: THE PIMCO ESG SCORING SYSTEM
PEER ASSESSMENT
Leading Practice            −
Better Than Peers           −
In-line with Peers           −
Weaker Than Peers         −
SignificantConcerns
−
TREND ANALYSIS
Improving
Stable
Deteriorating
FUNDAMENTAL VALUATION
Cheap
Fair
Rich
PIMCO ESG SCORE
5.0
−
Leading Practice
1.0
−
Significant Concerns
4.0
−
Better Than Peers
2.0
−
Weaker Than Peers
3.0
−
−
−
−
−
−
−
In-line with Peers
Source: PIMCO. For illustrative purposes only.

Integrating ESG in Corporate Credit Research 
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© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
Social (25% of PIMCO ESG Score)
■
Systemic importance and regulatory environment. In the postcrisis regulatory 
environment, the largest banks often offer the greatest protections to creditors 
due to tighter regulatory scrutiny and higher capital and liquidity standards, even 
in the context of potential “bail-in” for creditors in a resolution. Systemic impor-
tance is a negative factor only when a bank’s business activities create negative 
social externalities.
■
Integration of ESG in underwriting and product safety assesses a bank’s commit-
ment to providing financing to underserved market segments in a safe and sound 
manner (e.g., without exposing itself to higher losses or potential regulatory fines).
■
Customer privacy and data security is at present a subjective measure, given that 
few banks provide usable reporting. We reserve our highest scores for companies 
that have communicated strategic investments in data security and have had no 
public data security breaches.
Governance (60% of PIMCO ESG Score)
■
Culture and business conduct represents a forward-looking view of the bank’s 
internal business culture and ethical performance. We incorporate quantitative 
measures (such as the volume and severity of legal and regulatory settlements) 
along with more  forward-looking inputs (such as the company’s reputation in the 
marketplace and recent controversies).
■
Risk management and risk appetite represents our view of bank management’s 
willingness to embrace risk as well as the company’s capacity to manage those risks 
over the business cycle. We consider how management balances short-term return 
FIGURE 2: ESG HEATMAP FOR MAJOR BANKS BY REGION
15% Environmental
Sustainable Lending Impact
Environmental & Sustainability Plan
Green Bond Issuance
25% Social
Systemic Importance / Regulatory Environment
Integration of ESG in Underwriting / Product Safety
Customer Privacy & Data Security
60% Governance
Culture / Business Conduct
Risk Management / Risk Appetite
Accounting Quality
Board Quality
Human Capital (training, expertise, incentives)
US
Canada
UK
Europe
(Core)
Australia
Japan
China
Weaker
Average
Stronger
Legend:
ESG Quality
Source: PIMCO analysis as of 30 June 2018. Major banks include global and domestically systemically impor-
tant banks in each region. Percentages (15%, 25%, 60%) represent the relative weighting of each ESG pillar 
in the overall ESG score.

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targets against long-term solvency, how the company’s loan portfolio and loss rates 
have performed over business cycles, the level of its mergers and acquisitions appe-
tite, and whether management has set and met achievable targets.
 
■
Accounting quality assesses whether the bank’s disclosures are credible. We avoid 
banks and banking systems that delay the recognition of bad debts for years, or 
“optimize” risk-weighted assets to report higher capital ratios and/or to enable 
higher payouts. 
 
■
Board quality assesses the bank’s board leadership, diversity, expertise, and track 
record of replacing underperforming directors. Possible negative qualities include 
having a combined CEO/chairperson role, receiving ongoing regulatory citations, 
or having an inconsistent strategic focus. 
 
■
Human capital assesses the quality of the nonexecutive employee base by deter-
mining how well the company attracts and retains top candidates and provides 
excellent training, ethics, and advancement opportunities. 
Integration into Portfolio Management
PIMCO’s credit analysts have reviewed the ESG performance of over 2,200 parent issu-
ers to date, with ESG scores highlighted in research notes alongside PIMCO credit rat-
ings. Analysts’ views include narrative and rationales for material ESG factors that have the 
potential to impact investment performance. 
Over time, these assessments have been relevant in shaping investments in our credit 
portfolios. For example, a portfolio manager may decide to switch between two similarly 
rated bank bonds trading at comparable spread levels based on their relative ESG scores 
and trajectory. Figure 3 illustrates the four valuation quadrants used for analyzing poten-
tial bank investments: 
1. Invest in banks trading at attractive valuations and with strong ESG profiles (e.g., 
national champion banks that have resolved legacy litigation).
2. Engage with banks trading inexpensively but that have weaker ESG profiles (e.g., banks 
with a strong long-term track record that are working to recover from recent risk or 
reputational controversies).
3. Reduce exposures to banks trading at unattractive valuations despite strong ESG pro-
files (e.g., banks whose spread levels already reflect an expectation of pristine credit 
and ESG performance).
4. Sell/avoid companies with unattractive valuations and weak ESG profiles (e.g., banks 
with persistent regulatory citations and/or strategic challenges; management teams 
taking underwriting shortcuts or excessive capital payouts to maximize short-term 
equity returns).

Integrating ESG in Corporate Credit Research 
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FIGURE 3: ESG RELATIVE VALUATION
ESG Value 
Option-Adjusted Spread (OAS)
Worst
Best
Rich
Cheap
Invest
Engage
Avoid
Reduce
Source: PIMCO. For illustrative purposes only.

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ROBECO
ALTICE: AN ESG CREDIT CASE STUDY
Jankees Ruizeveld 
A corporate bondholder’s primary focus is on the issuer’s ability to repay debt. The key 
focus of credit analysis is therefore the cash-generating capacity of the company and the 
quality of the cash flows. The Robeco credit analysts perform this analysis—for every 
­company—by looking at five factors: the company’s business position, corporate strategy, 
financial profile, corporate structure, and environmental, social, and governance (ESG) 
profile (sustainability factors; see Figure 1). These five factors are obviously not standalone 
indicators but are often intertwined; for instance, a change in ownership can affect a com-
pany’s financial position, and an international expansion strategy may introduce country-
specific risks into the business position.
Based on these five factors, the credit analysts assign fundamental (F) scores to 
all companies under coverage. These fundamental scores—from −3 (very weak) to  
+3 (very strong)—express the overall fundamental view on the company given its 
credit ratings.
RANGE OF SOURCES OF ESG INFORMATION
The analysts consider the impact of key sustainability factors on the credit fundamen-
tals of the issuer. These key ESG factors differ per sector. For example, for the automo-
tive sector, criteria include product quality and emission reduction. For the food and 
beverage sector, factors such as sustainable sourcing of raw materials and responsible 
marketing are more important. To form an opinion on how companies are positioned 
on these factors, the analysts use multiple sources. An important input is the annual 
Corporate Sustainability Assessment of RobecoSAM (Robeco’s sister company that spe-
cializes in sustainability investing). This assessment contains detailed information on 
companies’ ESG characteristics. We also use specialized external research from third-
party providers such as Glass, Lewis & Co. (governance, voting) and Sustainalytics. 
ESG insights are further strengthened through cooperation with Robeco’s Governance 
& Active ownership team. 
Higher risk associated with ESG can result in a lower F score for an issuer. The five factors 
on which the F score is based do not have a fixed weight; their relative importance differs per 
sector and per company. An analyst, for example, can have a very constructive view on a com-
pany’s business position and strategy. However, if leverage is high while the company is heavily 
free-cash-flow negative, the weak financial position on its own has a very negative impact on 
the F score.

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© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
ESG IMPACT IN APPROXIMATELY 36% OF 
THE COMPANY PROFILES
Looking at the companies currently covered by the credit research team, we find that in 
36% of cases, ESG factors have a material impact on the assessment of the fundamen-
tal position. In the majority of those cases—32% to be precise—the impact is negative 
(Figure 2). In analyzing and investing in corporate bonds, the focus is tilted toward detect-
ing downside credit risks. This makes sense, as risk is asymmetrical for credit investors.  
A good risk management system at a bank, for instance, does not necessarily translate to 
a strong improvement in credit quality, but a weak risk management system may lead to a 
total collapse of the bank.
FIGURE 1: THE FIVE PILLARS OF CREDIT ANALYSIS
F
Score
Company characteristics
Industry characteristics
Industry trends/outlook
Market position
Country/sovereign risk
Leverage/Liquidity
Coverage
Expected recovery
Margins
Financial forecasts
Ownership structure
Corporate structure
Quality of covenants
Management 
strategy
Risk appetite
Growth strategy
Bondholder friendliness
Focus on downside risk
Financially material
issues
Absolute impact
matters
C
o
r
p
o
r
at
e 
S
tr
at
e
g
y 
 
 
E
S
G 
P
r
of
il
e 
 
 
C
o
r
p
o
r
at
e 
S
tr
u
ct
u
r
e 
 
Fi
n
a
n
ci
al
 P
r
of
il
e 
 
 
B
u
si
n
e
s
s 
P
o
si
ti
o
n 
Source: Robeco.

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A lower F score means that the risk of the company is perceived to be higher than that 
of comparable companies in the same rating segment. Thus, we demand higher spreads 
for names with lower F scores to compensate for the additional risks that become apparent 
from our analysis. 
EXAMPLE: ALTICE LUXEMBOURG S.A.
Altice Luxembourg S.A., a Luxembourg-based, Dutch-listed, and predominately French 
telecom operator, is an example of a company for which we have reduced the F score based 
on ESG factors. 
One major concern is the firm’s poorly designed corporate governance framework. 
Through a network of subsidiaries, Altice offers telecom services, such as cable TV, 
fixed line and mobile networks, and broadband, in many countries worldwide. The firm 
introduced a dual-share class structure—which deviates from the one-share, one-vote 
principle—and makes it possible for Patrick Drahi, founder and head of the company, 
to control the company via a 60.4% ownership of the voting shares. As president of the 
board, Drahi has the option to veto any board decisions and make binding nominations 
for executive directors (currently, the board has too few independent board members). 
This subpar governance structure raises the credit risk from a bondholder perspective and 
is the main reason sustainability factors contribute negatively to our fundamental view on 
Altice. In addition, Drahi would benefit excessively from a rising share price, as he would 
receive €1 billion of additional shares in the company if the share price were to triple from 
a predetermined point and over a certain period of time.
Another Altice governance issue is intragroup transactions concerning content rights, 
which may be beneficial for tax purposes but have a side effect of substantially increasing 
the leverage capacity of a subsidiary.
FIGURE 2: CONTRIBUTION OF ESG FACTORS TO FUNDAMENTAL VIEW
0%
5%
10%
15%
20%
25%
30%
35%
Negative
Positive
Source: Robeco. Data as of September 2017.

Altice: An ESG Credit Case Study
125
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
FIGURE 3: SPREAD GRAPH OF ALTICE LUXEMBOURG S.A. VERSUS ITS BENCHMARK
0
100
Underweight
Neutral
May-17
Jun-17
Jul-17
Aug-17
Sep-17
Oct-17
Nov-17
Dec-17
Jan-18
Feb-18
Mar-18
Apr-18
200
300
400
Pan-European HY Corp 2.5% Cap excl Fin - B - OAS
ATCNA 6.25 02/15/2025:OAS
500
600
700
800
Robeco engaged with Altice (starting in 2015) on good governance for several years, 
even attending its annual general meeting. The engagement was subsequently closed, how-
ever, as there was no progress.
As stated, we demand higher spreads for issuers with lower F scores to compensate for 
the additional ESG risks that have become apparent from our analysis. Prior to November 
2017, we believed these corporate governance risks were not reflected in the spreads of 
Altice bonds.
After the company reported disappointing financial numbers in November 2017, the 
investment community’s trust in Drahi faded. The company was not able to sustain its vir-
tuous circle of increasing debt, takeovers, and cost cutting as the market lost its faith in 
the execution of these plans. As a consequence, the Altice bond spreads widened signifi-
cantly (Figure 3). The company has since changed its focus (reducing complexity, selling 
noncore assets, and focusing on deleveraging), and the bond spreads began to reflect the 
higher corporate risk. Thus, we revised our view on the valuation of Altice bonds and 
added them to the relevant portfolios.

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UBS ASSET MANAGEMENT
BEYOND RATINGS: SUSTAINABILITY 
INTEGRATION IN FIXED INCOME
Christopher Greenwald and Francis Condon
One of the challenges cited for the integration of sustainability into fixed-income strat-
egies is the inconsistency in the environmental, social, and governance (ESG) data and 
ratings for sovereign versus corporate issuers. At UBS Asset Management (UBS-AM), we 
believe this difference can be overcome through a consistent approach to integration, one 
that moves beyond data and scores and focuses on the impact of sustainability on the fun-
damental financial assessment. 
FIXED INCOME AND THE LIMITATIONS OF ESG RATINGS
Significant differences exist between the sustainability ratings and data of sovereign and 
corporate issuers, which reflect fundamental differences in the nature of the entities 
themselves. Corporate issuers’ sustainability ratings generally reflect the key performance 
indicators and metrics reported by companies in their public disclosures, while ratings on 
sovereigns are composed of national and international socioeconomic statistical data that 
reflect the overall state of the entity’s environment, economy, and society. These differ-
ences in sustainability ratings pose challenges for sustainability themed fixed-income strat-
egies, primarily because the integration of sustainability generally occurs at the level of 
sustainability ratings. We believe this represents a misunderstanding of the limitations of 
sustainability ratings and their place in the integration of sustainability into fixed income 
in general. 
First, sustainability ratings reflect historical performance metrics rather than forward-
looking analysis; the latter is essential for investment recommendations in active asset man-
agement. Undoubtedly, the data sets from large ESG data providers are invaluable for the 
finance industry, given the challenges of collecting and providing consistent information. 
However, ratings based on such data are, by their very nature, backward looking and based 
on reported information and events in the public domain. They reflect what has happened 
rather than what might happen in the future.
Second, in our view, sustainability ratings generally capture a wide range of top-
ics, making them too broad to be immediately applicable to the investment process. 
Furthermore, sustainability ratings generally fail to reflect the differences between fixed 
income and equity in terms of materiality. Fixed-income investors are more concerned 
with downside risk arising from sustainability, whereas equity investors tend to focus on 
upside growth potential.
Third, sustainability ratings are, by definition, independent from the actual financial 
analysis of the issuers themselves. Inherently, third-party sustainability rating agencies work

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FIGURE 1: UBS-AM’S INTEGRATED APPROACH TO CREDIT RESEARCH
UBS SI Research and Engagement
Materiality
Identify material ESG factors 
and issues for credit assessment
Top-down views
Long-term sustainable expertise 
with issue and trend analysis
Bottom-up research
Ongoing collaboration for
company analysis
Engagement
Proactive engagement with issuers
Additional ESG data sources
Company and country information
Dedicated ESG information
Meetings and calls
Dedicated ESG discussions
External ESG data and
research providers
Underlying data, industry positions,
ESG ratings
UBS Fixed-Income 
Credit Research (25+)
In-depth sector and 
company knowledge
Forward-looking 
assessment of ESG risks 
(direction)
Sustainability impact on the credit profile
independently of the investment process, and their analyses are not directly applied to 
the fundamental credit assessment. Although sustainability ratings provide an important 
information starting point, for the rating to be truly meaningful, credit analysts and port-
folio managers need to apply those ratings to the fundamental financial credit assessment.
UBS-AM’S PROPRIETARY CREDIT ASSESSMENT: 
MATERIALITY ANALYSIS FOR SUSTAINABILITY 
INTEGRATION (SI) INTO FIXED INCOME
At UBS-AM, we are of the view that ESG integration is strongest when credit analysts inte-
grate the data into their own investment recommendations. Our credit analysts sit at the 
center of ESG integration in fixed income because we believe that by doing so they are 
best placed to utilize their in-depth knowledge of issuers, and their experience in funda-
mental analysis, to provide the context in which to consider sustainability issues. Crucially, 
UBS-AM credit analysts make forward-looking judgments in applying the sustainabil-
ity issues to the projections that make up their credit recommendations. This judgment 
applies as much to ESG issues as it does to financial factors, and as such, it distinguishes 
the integration done by the credit analysts from ESG data gathering or scoring. 
The integration process begins with UBS-AM’s materiality analysis, developed by our 
sustainable investment research team in collaboration with our credit analysts (see Figure 1). 
The frameworks for identifying the most material issues from a credit perspective are

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based on the recommendations of the Sustainability Accounting Standards Board, the 
weighting methodologies of various data providers, and discussion with individual credit 
analysts. 
Based on the most material sustainability issues from a credit perspective, the credit 
analysts then assess a set of key ESG strengths and weaknesses for each issuer. Crucially, 
the credit analysts focus their research and analysis on whether—and to what extent—the 
most material sustainability issues impact the fundamental creditworthiness and risk pro-
file of the issuer. They also look at recent controversies for an additional check on manage-
ment’s abilities, and for potential future liabilities. This helps to identify possible material 
impacts on creditworthiness.
The credit analysts determine whether the scale of any ESG issues is enough to impact 
the credit assessment. They then provide an explicit assessment score for each issuer along 
with an analysis of whether (and to what extent) sustainability factors have an impact on 
the fundamental credit recommendation. The key test of this assessment is whether the 
scale of the ESG risks is significant enough to become one of the key considerations in the 
development of the issuer’s creditworthiness going forward, as well as the extent to which 
the ESG analysis leads to a change in credit opinion. 
CASE STUDY A: CORPORATE HIGH-YIELD ISSUER
This North American high yield issuer is a private correctional/detention center operator 
for the US Federal Bureau of Prisons (BOP). The private prison industry fulfils a critical 
need for the US government, given the significant overcrowding at BOP facilities. However, 
studies indicate that private contract prisons incur more safety and security incidents per 
capita than comparable government-operated institutions, and require additional over-
sight. In terms of these highly sensitive human rights issues, the issuer is facing substantial 
criticism related to serious allegations of human rights abuse and neglect of inmates in its 
facilities, including the provision of inadequate health care, use of solitary confinement, 
and incidence of physical assaults. As a result, it faces a number of lawsuits and allegations. 
Given the high sensitivity of its core business activities and evident weakness in managing 
material risks, we see the investment risk skewed very much to the downside. The ESG 
analysis is weak and has a negative impact on the overall credit assessment of this issuer.1 
CASE STUDY B: INVESTMENT-GRADE  
SOVEREIGN ISSUER
This European sovereign issuer demonstrates a relatively stable political environment, with 
high trust in government and institutional effectiveness and low levels of corruption. It 
has a high social welfare framework and strong social performance on metrics such as 
investments in education and strong health care benefits. The country also demonstrates 
1 Sources: Company annual disclosures, corporate sustainability reporting, independent new sources, and con-
troversy analysis.

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high levels of renewable energy use and recycling, and has a long-term outlook for sustain-
able sourcing of energy in the future. The strong performance on sustainability metrics 
strengthens the view of the long-term creditworthiness, resulting in a positive assessment 
of the impact of sustainability on the longer-term credit risk and fundamental credit 
assessment.2 
CONCLUSION
Although the data are fundamentally different, the analysts apply the same approach of 
assessing the impact of these data on their fundamental credit assessment. This allows for 
consistent sustainability ratings by the credit analysts, reflecting a common approach to 
integration for both sovereign debt and corporate bond issuers that can be applied across 
a diverse range of positions in our credit portfolios. 
2 Sources: United Nations data, economic and environmental statistics, social metrics, and rankings.

This page is intentionally blank

FIXED-INCOME  
CASE STUDIES:  
SOVEREIGN DEBT

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COLCHESTER GLOBAL INVESTORS
INTEGRATION OF ESG FACTORS INTO 
SOVEREIGN BONDS: A CASE STUDY 
OF RUSSIA
Claudia Gollmeier, CFA, CIPM
Colchester Global Investors is a sovereign bond and currency manager. The factors that 
underpin its investment process are wide ranging, incorporating valuations and macro-
economic and financial analysis, alongside environmental, social, and governance (ESG) 
factors, as shown in Figure 1. Since the inception of the firm in 1999, responsible investing 
has been an integral part of the investment process, to better assess risk and generate sus-
tainable, long-term returns.
FIGURE 1: COLCHESTER GLOBAL INVESTORS ESG INTEGRATION PROCESS
• Macroeconomic Analysis:
 e.g., Real economy and composition
• Fiscal Position:
 e.g., Revenue/expenditure composition and
 elasticity
• Debt (gross and net):
 e.g., Incl. contingent liabilities, ownership and
 financing structure
• Governance:
 e.g., Institutinal strength, business
 environment, control of corruption,
 government effectiveness
• Social:
 e.g., Human development, demographics,
 social and political stability
• Environmental:
 e.g., Disaster risk management, resource
 governance and sustainability
Financial Stability Score
Debt and External
Sustainability Analysis:
ESG
Factors:
Valuations Adjusted
• External Position:
 e.g., Balance of payments composition,
 external debt (public/private)

Integration of ESG Factors into Sovereign Bonds: A Case Study of Russia 
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COLCHESTER GLOBAL INVESTORS ESG INTEGRATION 
FOR SOVEREIGNS 
The integration of ESG factors is a holistic approach to investing and involves an enhanced 
analysis of sovereigns to better assess their ESG-related risks and opportunities. Colchester 
assigns a Financial Stability Score (FSS) to a country based on the overall balance sheet 
strength and ESG factors. The FSS ranges from +4 to –4 for those countries and currencies 
deemed to make it into the opportunity set and will lead to exclusion for those rankings 
below –4. However, the FSS is determined after a review of the ESG factors, and a strong 
sovereign balance sheet might be heavily penalized due to weak ESG factors. The follow-
ing case study demonstrates how a country with a strong balance sheet can be significantly 
negatively affected by ESG factors.
CASE STUDY FOR ESG INTEGRATION: RUSSIA
At the time of this writing, Russian 10-year government bonds offered an attractive 
real yield1 of around 3% with a ruble undervaluation of over 10% versus the US dollar 
in purchasing power parity.2 This valuation needs to be considered in conjunction with 
a thorough balance sheet analysis and ESG factors to ascertain the underlying invest-
ment risk.
Figure 2 shows a sample of economic variables that would generally be consid-
ered in the analysis; it would appear to show Russia having a strong balance sheet. 
Economic growth is positive again since 2017, and inflation has fallen significantly 
from double digits to below 3%. Fiscal accounts are almost balanced, a primary sur-
plus is expected by 2018, and gross government debt is low—below 20% of gross 
domestic product (GDP). Historically, oil revenues constituted around 50% of federal 
revenues but fell to around 40%. This narrow economic base is a vulnerability to the 
economy, as are the current economic sanctions.3 Conversely, the external position 
looks strong, with a rising current account surplus, low external debt, and high for-
eign currency reserves of almost 23% of GDP at the end of 2017. In conclusion, the 
balance sheet looks strong.
1 Real yields are defined as the yield on a government bond minus Colchester’s forecast of the next two years’ 
consumer price inflation.
2 Colchester calculates purchasing power parity by using country consumer and producer price indices, and 
foreign exchange rates. 
3 Sanctions were imposed in the aftermath of Russia’s military intervention in Ukraine, which led to a plunge 
of net foreign direct investment by two-thirds during 2014.

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FIGURE 2: A SNAPSHOT OF RUSSIA’S BALANCE SHEET
ECONOMIC INDICATORS & FORECASTS (% OF GDP UNLESS STATED)
2013
2014
2015
2016
2017
2018F
Real GDP growth (%yoy)
1.8
0.7
–2.5
–0.2
1.5
1.7
Inflation EoP (%yoy)
6.5
11.4
12.9
5.4
2.5
3.5
Federal Govt Revenue
18.3
18.3
16.4
15.6
16.2
15.5
of which oil-related
9.3
9.5
7.1
5.6
5.8
5.9
General Fiscal Balance
–1.2
–1.1
–3.4
–3.7
–1.5
0.0
primary balance
–0.8
–0.7
–3.1
–3.2
–0.9
0.4
General Gross Govt Debt
12.7
15.6
15.9
15.7
17.4
18.7
Current Account
1.5
2.8
5.0
2.0
2.6
4.5
External Debt
32.7
29.1
38.0
40.0
34.3
31.0
Fx Reserves
20.5
15.9
22.7
24.0
22.7
24.0
Source: IMF, CBR, Colchester Global Investors. 
Abbreviations: FX, foreign exchange.
Russia’s Balance Sheet Is Strong but 
It Faces Weak Governance
Although Russia’s balance sheet is strong, its governance factors rank very low according to 
the World Bank’s Worldwide Governance Indicators. The governance factor (“G”) strongly 
influences the “S” (social) and “E” (environmental) factors as it (the government) sets the 
policies for environmental and social matters, and, in turn, influences the country’s long-
term sustainable economic growth.
Figure 3 displays the six governance indicators, of which all are low (and most have 
not improved over time). The low and deteriorating scoring on the government indicator 
is not surprising, given the authoritarian government. Similarly, the rankings for rule of 
law and control of corruption remain relatively low and unchanged over time. This does 
not bode well for foreign direct investment inflows in the absence of clearly defined prop-
erty rights, international sanctions, and hence, long-term economic growth. These factors

Integration of ESG Factors into Sovereign Bonds: A Case Study of Russia 
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significantly weigh negatively on Russia’s FSS and will be considered in conjunction with 
the social and environmental data discussed below.
Russia’s Human Development Index Ranks Highly  
but Life Expectancy Is Lagging 
Russia’s Human Development Index (HDI) is high and has improved over time, accord-
ing to United Nations’ data, while its life expectancy index lags behind all other subcom-
ponents (Figure 4, Chart 1). This is also evident when comparing Russia to its regional 
peers (Figure 4, Chart 2). Reasons for the low life expectancy might be linked to empiri-
cal results from the Organisation for Economic Co-operation and Development (OECD), 
which suggest that life expectancy does not only depend on the health system and that 
higher national income and health spending are also main drivers. Findings are that a 
FIGURE 3: RUSSIA’S WORLDWIDE GOVERNANCE INDICATORS4
0
20
40
60
80
100
Voice of Accountability
Political Stability and Absence of 
Violence/Terrorism
Government Effectiveness
Regulatory Quality
Rule of Law
Control of Corruption
Percentile Rank (0 to 100)
Worldwide Governance Indicators
2005
2010
2016
Source: World Bank, Worldwide Governance Indicators (www.govindicators.org).
4 The Worldwide Governance Indicators are a research dataset summarizing the views on the quality of gover-
nance provided by a large number of enterprise, citizen, and expert survey respondents in industrial and develop-
ing countries (Worldwide Governance Indicators: 0 = weak level of governance; 100 = high level of governance).

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FIGURE 4: RUSSIA’S HUMAN DEVELOPMENT INDEX AND LIFE EXPECTANCY
Chart 1: Russia’s Human Development Index5 Components
0.65
0.70
0.75
0.80
0.85
1990
1995
2000
2005
2010
2011
2012
2013
2014
2015
Life expectancy index
Education index
GDP index
Human development index (HDI) value
Chart 2: Russia’s Low Life Expectancy
55.00
1950-1955
1960-1965
1970-1975
1980-1985
1990-1995
2000-2005
2010-2015
2020-2025
2030-2035
2040-2045
2050-2055
2060-2065
2070-2075
2080-2085
2090-2095
60.00
65.00
70.00
75.00
80.00
85.00
90.00
95.00
Life expectancy at birth (years)
Year
Life Expectancy at birth (both sexes combined)
EUROPE
Eastern Europe
Russian Federation
Sources: United Nations, Colchester.
5 HDI considers three basic aspects of human development—leading a long and healthy life, being knowl-
edgeable, and enjoying a decent standard of living.

Integration of ESG Factors into Sovereign Bonds: A Case Study of Russia 
137
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
10% increase in health spending per capita (in real terms) is attributable to a 3.5-month 
increase in life expectancy.6
In the case of Russia, as a very high human development country,7 its expenditure 
of 35.7% of GDP is relatively low compared to the OECD-27 average of 45.6% of GDP, 
and the European Union-28 average of 47% of GDP as of 2015 (Figure 5, Chart 1). The 
expenditure breakdown shows further that other countries spend more on social pro-
tection, education, and health. In contrast, Russia appears to have a higher focus on 
defense spending. The future consequences of Russia’s low levels of health spending, 
coupled with an unfavorable demographics profile, might impact life expectancy more 
negatively (Figure 5, Chart 2). This, in turn, will reduce the overall future workforce, 
which will lead to lower productivity and future economic growth, and may likely impact 
sovereign creditworthiness negatively in the longer term. Again, the social aspect, while 
it does not have an imminent economic impact, will be unfavorable in the long term 
with regard to the FSS.
Russia’s Resource-Rich Economy Ranks Low on  
Its Management 
A review of environmental factors includes environmental disaster risk management, sus-
tainability, and resource governance to lessen the environmental impact. In the case of 
Russia, resource governance is of primary importance because of the contribution of oil, 
gas, and mineral extraction to the country’s balance sheet. 
The Resource Governance Index (RGI) produced by the National Resource 
Governance Institute “assesses policies and practices that authorities employ to gov-
ern their countries’ oil, gas and mining industries.”8 Russia’s vast oil and gas resources 
allowed it to establish two sovereign wealth funds. The Reserve Fund was intended to 
top up the federal budget during falling oil prices, and the National Wealth Fund was 
dedicated to supporting Russia’s pension system long term. Unfortunately, as oil prices 
fell and deficits rose, the authorities drew on the Reserve Fund in 2015 and used the 
National Wealth Fund for economic stimulus purposes, instead of using these reserves 
for economic diversification efforts, future generations, and/or rainy-day savings. The 
Reserve Fund was almost depleted at the end of 2017, and the authorities decided to 
merge it with the National Wealth Fund. This  highlights how natural resource revenue 
management impacts a country’s balance sheet. The RGI puts Russia at the bottom of its 
“weak” category (Figure 6). 
6 Health at a Glance 2017, OECD Indicators.
7 High human development country, according to the Human Development Index.
8 https://resourcegovernance.org/sites/default/files/documents/2017-resource-governance-index.pdf, p. 7

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138
FIGURE 5: RUSSIA’S EXPENDITURE BREAKDOWN AND HEALTH SPENDING
Chart 1: Russia’s Expenditure Breakdown for 2015 (% of GDP)
0
10
20
30
40
50
TOTAL
General public services
Defense
Public order and safety
Economic affairs
Environmental protection
Housing and community amenities
Health
Recreation, culture, and religion
Education
Social protection
OECD average (27 countries)
EU-28
Russia
Chart 2: Russia’s Low Health Spending
AUS
AUT
BEL
BRA
CAN
CHL
CHN
COL
CRI
CZE
DNK
EST
FIN
FRA
DEU
GRC
HUN
ISL
IND
IDN
IRL
ISR
ITA
JPN
KOR
LVA
LTU
LUX
MEX
NLD
NZL
NOR
POL
PRT
RUS
SVK
SVN
ESP
SWE
CHE
TUR
GBR
USA
R² = 0.54
65
70
75
80
85
0
2000
4000
6000
8000
10000
Life expectancy in years
Health spending per capita (USD PPP)
Sources: OECD Health Statistics 2017, World Bank, OECD, Federal Treasury of the Russian Federation, 
Eurostat, Colchester.

Integration of ESG Factors into Sovereign Bonds: A Case Study of Russia 
139
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
FIGURE 6: RUSSIA’S RESOURCE GOVERNANCE INDEX
20
40
60
80
100
44th| Ukraine |
43rd| Timor-Leste |
42nd| Tanzania |
41st| Mozambique |
40th| Zambia |
39th| Oman |
38th| Kyrgyz Republic |
37th| Morocco |
36th| Tanzania |
35th| Mali |
34th| Bolivia |
33rd| Kuwait |
32nd| Ecuador |
31st| Niger |
30th| Cameroon |
29th| China |
28th| Côte d’Ivoire |
27th| Malaysia |
26th| Tunisia |
25th| Kazakhstan |
24th| Ghana |
23rd| South Africa |
22nd| Argentina |
21st| Philippines |
20th| Burkina Faso |
19th| Mexico |
18th| Botswana |
17th| Mexico |
16th| Peru |
15th| Mongolia |
14th| Trinidad and Tobago |
13th| Ghana |
12th| Indonesia |
11th| Indonesia |
10th| Colombia |
9th| India |
8th| Australia (Western) |
7th| Colombia |
6th| Brazil |
5th | United States of America (Gulf of Mexico) |
4th| Canada (Alberta) |
3rd| United Kingdom |
2nd| Chile |
1st| Norway |
SCORE
86
81
77
75
74
71
71
71
70
69
68
68
67
64
64
62
61
61
60
59
58
57
57
56
56
56
56
55
55
54
54
54
54
54
53
53
52
51
50
50
50
49
49
49
89th| Eritrea |
88th| Turkmenistan |
87th| Libya |
86th| Sudan |
85th| Equatorial Guinea |
84th| Democratic Republic of Congo |
83rd| Myanmar |
82nd| Mauritania |
81st| Zimbabwe |
80th| Uzbekistan |
79th| Cambodia |
78th| Yemen |
77th| Myanmar |
76th| South Sudan |
75th| Democratic Republic of Congo |
74th| Venezuela |
73rd| Algeria |
72nd| Chad |
71st| Afghanistan |
70th| Angola |
69th| Saudi Arabia |
68th| Madagascar |
67th| Bangladesh |
66th| Cuba |
65th| Gabon |
64th| Lao PDR |
63rd| Guinea |
62nd| Iran |
61st| Iraq |
60th| Egypt |
59th| Bahrain |
58th| Congo |
57th| Ethiopia |
56th| Guatemala |
55th| Nigeria |
54th| United Arab Emirates |
53rd| Qatar |
52nd| Liberia |
51st| Uganda |
50th| Russia |
49th| Sierra Leone |
48th| Tunisia |
47th| Azerbaijan |
46th| Papua New Guinea |
45th| Vietnam |
48
47
47
46
46
45
44
44
43
42
42
41
40
39
39
39
38
38
38
38
36
36
36
36
36
35
34
34
33
33
33
32
31
30
30
29
29
29
27
25
22
21
18
11
10
Oil and gas
Mining
Good
Satisfactory
Weak
Poor
Failing
Source: National Resource Governance Institute (score: 0 = weakest level of governance; 100 = highest level of 
governance).

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140
What Is Russia’s Financial Stability Score?
The analysis provided above indicates a solid balance sheet for Russia—low debt levels and 
relatively solid fiscal and external positions, combined with an attractive real yield of the 
sovereign debt, all of which would suggest an attractive investment proposition. However, 
Russia’s weak ESG factors led to a significant downward adjustment of the real yields and 
currency valuation via the FSS.
Colchester’s holistic approach to the integration of ESG factors via a detailed analysis 
of the balance sheet and ESG factors, as demonstrated in the case study of Russia, attri-
butes an FSS of –4 (the lowest score) for Russia’s bonds and currency.  
HOW DOES OUR FINANCIAL STABILITY SCORE  
AFFECT OUR INVESTMENT DECISIONS?
Following our assessment of real yield and real exchange valuations, the FSS is applied 
prior to the portfolio construction process. Were there two countries with equal real yields, 
the one with the higher FSS would be favored, as it is reasonable to assume that a country 
with higher standards on all or some factors would have a better return outcome.
Colchester believes that countries with better ESG standards tend to produce better 
economic growth, more stable balance sheets, and better long-term and sustainable finan-
cial outcomes.

141
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
FUTUREGROWTH ASSET MANAGEMENT (PTY) LTD.
RESPONSIBLE INVESTING IN DEBT CAPITAL 
MARKETS: UNPACKING GOVERNANCE FOR 
STATE-OWNED ENTITIES 
Futuregrowth’s Credit Team
Futuregrowth Asset Management has been a substantial funder of national development 
through its investment in the debt issued by many of South Africa’s state-owned enterprises 
(SOEs). SOEs, by their very nature as publicly funded entities, are not subject to the same mar-
ket discipline or shareholder oversight as other entities. Recent corporate failures (African 
Bank Limited, Steinhoff International Holdings NV), as well as serious allegations of malfea-
sance at certain SOEs (as revealed by South Africa’s Public Protector), have demonstrated the 
need for appropriate and strong governance checks and balances—applied equally to both 
public and private companies. In addition, the assessments of S&P Global Ratings (a subsid-
iary of Standard & Poor’s Financial Services LLC) and Fitch Ratings Ltd., which place South 
Africa’s sovereign debt at one level above a rating of junk, have raised concerns that the govern-
ment debt guarantees to SOEs (which totaled ZAR467 billion at the end of March 2017) pose 
significant risks to South Africa’s deficit and economic and ratings outlook (see Figure 1). 
At the end of August 2016, Futuregrowth made a public statement that it would sus-
pend lending to some South African SOEs until an in-depth governance due diligence 
could be concluded. Following the lending suspension, we initiated a self-imposed embargo 
on the listed instruments of the six SOEs until we better understood the governance at 
these entities and were able to formulate a forward-looking investment view. We have sub-
sequently lifted our lending suspension on the Land and Agricultural Development Bank 
of South Africa (Land Bank), the Industrial Development Corporation of South Africa 
Limited (IDC), the Development Bank of Southern Africa (DBSA), and the South African 
National Roads Agency SOC Ltd. (SANRAL) (conditional) upon finalizing our reviews. 
Although the yields in the named SOEs did not materially increase, we noted that certain 
SOEs had difficulty accessing the local capital markets following our suspension.
INCORPORATING CORPORATE GOVERNANCE  
INTO CREDIT ANALYSIS 
Futuregrowth worked with the six largest SOEs in South Africa (Land Bank, DBSA, IDC, 
SANRAL, Transnet SOC Ltd., and Eskom Holdings SOC Ltd.) to conduct a detailed gover-
nance due diligence for each entity. We recognize that good governance is a key factor in 
ensuring that public entities (mostly funded with public money) are sustainably managed 
for the long-term and are able to deliver on their developmental mandates.

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During the governance due diligence process, we assessed various criteria through a 
combination of:
 
■
conducting onsite due diligence, including meeting with key members of the 
board and management to verify processes; and
 
■
reviewing board minutes, policies, charters, terms of reference, and other docu-
mentation to assess evidence of good governance in action.
We found that at present, the governance reporting is remarkably vague and should 
be vastly improved so that investors can make informed decisions and allocate capital to 
sustainable, well-managed entities.
Futuregrowth’s due diligence process highlighted certain flaws in the markets and 
our approach to understanding SOE governance, and showed the need for our analyti-
cal approach to evolve to consider these aspects more explicitly. Corporate governance of 
SOEs is better understood as a “web” of oversight by various stakeholders (e.g., sharehold-
ers, directors, employees, regulators, suppliers, financiers, auditors, and corporate secre-
taries) as well as a range of policies, practices, protections, and disclosures. We realized 
that a central focus on the board of directors in our governance reviews was not appropri-
ate because the governance of SOEs also relies on parliament and the executive authority 
(i.e., the ministry responsible for that SOE). 
Some of the key learnings outlined below, arising from extending our focus to 
“beyond the board of directors” to the legislative governance framework in which each 
FIGURE 1: SOVEREIGN DEBT AND CONTINGENT LIABILITIES
80%
70%
60%
50%
40%
30%
20%
10%
12.3% 12.3%
27.9% 25.0% 22.3%
10.7% 10.7%
21.8% 26.4% 29.0%
13.4%
14.4%
32.2% 35.6%
15.6% 15.5%
38.2% 41.0%
19.1%
20.0%
43.8% 45.5% 48.6%
20.5% 20.6%
50.3% 51.4%
20.4% 21.9%
52.2%
21.5%
0%
2005/06
2006/07
2007/08
2008/09
2009/10
2010/11
2011/12
2012/13
2013/14
2014/15
2015/16
2016/17
2017/18
2018/19
2019/20
2021/22
14.1%
Provisions & Contingencies/GDP
Net Loan Debt/GDP
Source: National Treasury.

Responsible Investing in Debt Capital Markets: Unpacking Governance for State-Owned Entities 
143
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
SOE operates, meant that we also considered the layer of governance that exists between 
the board and its executive authority. One key challenge in looking beyond the board of 
directors to the overarching legislative framework is the concern of instances where the 
law is inconsistent with governance recommendations (which are voluntary by nature). In 
our view, the board of directors of the SOEs is best placed to advocate for a stronger align-
ment of its enabling legislation with corporate governance best practice. 
GOVERNANCE IMPROVEMENTS: LAND BANK
Futuregrowth identified many areas for improvement across the SOEs we analyzed. We share 
here some of these governance recommendations and improvements with regard to Land 
Bank, the first SOE we cleared following the lending suspension. Our engagement with 
Land Bank was fruitful and positive. In the months since the completion of our due diligence, 
Land Bank has been able to access the capital markets successfully, raising longer-term fund-
ing at lower interest rates and in greater amounts than they were previously able to (Figure 2).
Some outcomes of the governance negotiations included improvements to board  
decision-making structures and processes, and changes to legal agreements.
In principle, we agreed with Land Bank with regard to the inclusion of specific legal 
protections in any future bilateral loan agreements, and possible changes to its Domestic 
FIGURE 2: LAND BANK PRICING AND ISSUANCE TRENDS
 
LAND BANK
 
MARCH 2017
AUGUST 2017
MARCH 2018
 
3-YEAR 5-YEAR
1-YEAR
3-YEAR 5-YEAR
1-YEAR
3-YEAR 5-YEAR
VOLUMES
Target issuance size
ZAR750 m
ZAR750 m–ZAR1 bn
ZAR1.5 bn–ZAR2 bn
Number of participating bids
11
9
12
22
33
9
6
12
Bids received (ZAR, m)
553
283
1,199
1,337
2,553
1,138
614
1,270
Bids allocated (ZAR, m)
523
233
331
243
426
500
245
1,270
Bid cover (×)
1.06
1.21
3.62
5.50
5.99
2.28
2.51
1.00
SPREADS
Pricing guidance (bps)
180-195 270-285 120-130 165-175 240-255 90-120 130-150 190-230
Clearing spread (bps)
190
285
115
155
255
110
149
215
Source: Futuregrowth; bank auction outcomes.
Abbreviations: bn, billions; bps, basis points; m, millions.

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144
Medium Term Note Program documentation. A key focus of these protections is to main-
tain the stability of the relationship with the current Executive Authority.
INCREASED PUBLIC DISCLOSURE AND TRANSPARENCY
As part of our engagement with Land Bank, we have agreed with the board and manage-
ment that they will undertake regular public reporting on key matters in a bid to facili-
tate monitoring and transparency (see Figures 3 and 4). We recognize that governance is a 
dynamic process, the monitoring of which requires ongoing vigilance and engagement with 
management and shareholders. To this end, we have agreed with the other SOEs that they 
will also undertake regular public reporting on similar key matters (see Figures 3 and 4). 
KEY LEARNINGS
We have identified some key learnings and broad categories for governance improvements 
that asset managers could apply when assessing SOEs and listed corporate entities that 
access funding through the capital markets.
The “Who” Matters 
An organization can have all the trappings of governance (e.g., a board, committees, and 
policies), but if it has corrupt or ill-intentioned shareholders or leaders, then the corporate 
policies and practices are at risk. Improving governance means improving the selection 
and appointment process for individuals on company boards and board subcommittees, 
and for executive management positions. 
In the case of SOEs, attention to the “who” also implies improving the selection process 
of shareholder representatives (e.g., the ministers and their advisers). Thus, one has to look at 
the nomination and appointment processes for board and executive management members. 
 
■
Does the candidate vetting process incorporate detailed fit-and-proper back-
ground and other probity checks? 
 
■
Are candidates vetted for personal or political connections or conflicts? 
Board of Directors and Board Committees 
The composition of the board must be appropriate.
 
■
Are the quorum requirements and voting thresholds sufficient? 
 
■
How are conflicts of interest dealt with? Are members recused appropriately?
 
■
Are the disclosure and management of conflicts appropriate and adequate?
Governance Policies 
Organizations should have governance policies that cover their major business areas (e.g., 
procurement, lending) as well as key risk areas (e.g., dealing with politically exposed

145
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
FIGURE 3: OUTCOMES OF GOVERNANCE NEGOTIATIONS (PART 1)
LAND BANK
DBSA
IDC
SANRAL
OUTCOMES
DID THEY 
ALREADY 
HAVE 
THIS?
DID THEY 
AGREE TO 
IMPLEMENT 
THIS?
DID THEY 
ALREADY 
HAVE 
THIS?
DID THEY 
AGREE TO 
IMPLEMENT 
THIS?
DID THEY 
ALREADY 
HAVE 
THIS?
DID THEY 
AGREE TO 
IMPLEMENT 
THIS?
DID THEY 
ALREADY 
HAVE 
THIS?
DID THEY 
AGREE TO 
IMPLEMENT 
THIS?
AMENDMENTS TO LEGAL DOCUMENTATION
DMTN amendment to protect the stability of the 
relationship with the shareholding ministry
ý
˛
˝
˝
˝
˝
˝
˝
BOARD STRUCTURE AND COMPOSITION
Appropriate board size
˛
n/a
˛
n/a
˛
n/a
˝
˝
Balanced and appropriate mix of skills on the 
board and subcommittees
˛
n/a
˛
n/a
˛
n/a
˝
˝
Sufficient members on the ARC (including 
people with specific auditing skills)
˛
n/a
˛
n/a
˛
n/a
˝
˝
Staggering of director terms
˝
˛
˝
˝
˝
˝
˝
˝
A nominations committee
˝
˝
˛
n/a
˛
n/a
˝
˝
BOARD DECISION MAKING
Appropriate quorum and voting thresholds for 
board and subcommittees
˝
˛
˝
˝
˝
˛
˛
n/a
Regular public reporting on changes to key policies, 
terms of reference for board and subcommittees
˝
˛
˝
˛
˝
˛
˝
˛
Regular public reporting of all conflicts of 
interest of board members and management
˝
˛
˛
n/a
˝
˛
˝
˝
Annual disclosure of the number and quantum 
of deals approved at the various credit and 
investment committees
˝
˛
˛
˛
˝
˛
n/a
n/a

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146
FIGURE 4: OUTCOMES OF GOVERNANCE NEGOTIATIONS (PART 2)
LAND BANK
DBSA
IDC
SANRAL
OUTCOMES
DID THEY 
ALREADY 
HAVE  
THIS?
DID THEY 
AGREE TO 
IMPLEMENT 
THIS?
DID THEY 
ALREADY 
HAVE  
THIS?
DID THEY 
AGREE TO 
IMPLEMENT 
THIS?
DID THEY 
ALREADY 
HAVE  
THIS?
DID THEY 
AGREE TO 
IMPLEMENT 
THIS?
DID THEY 
ALREADY 
HAVE  
THIS?
DID THEY 
AGREE TO 
IMPLEMENT 
THIS?
Limitations to the delegated authority of 
particular credit, investment, and procurement 
committees
˝
˛
˝
˛
˝
˛
˝
˛
Timely and public reporting (via the website, 
Integrated Annual Report, and SENS) of all 
changes to the board and subcommittees terms 
of reference, mandate, and authority levels
˝
˛
˝
˛
˝
˛
˝
˛
CONFLICT MANAGEMENT
A conflicts-of-interest policy that prevents 
current directors (directly or indirectly via their 
investments or projects) from transacting from 
the SOE
˝
˛
˝
˛
˛
˛
n/a
n/a
An appropriate PEP policy
˛
n/a
˛
n/a
˝
˛
˝
˛
Disclosure of all transactions with PEPs in 
the Annual Integrated Report and/or website
˝
n/a
˝
˛
˝
˛
˝
˛
A cooling-off period restricting former directors 
from conducting business with the SOE
˝
˝
˝
˝
˝
˛
˝
˛
GOVERNANCE REVIEWS
Third-party governance assessments, the 
results of which are made public
n/a
n/a
˝
˛
˝
˛
˝
˛
RELATIONSHIP WITH EXECUTIVE AUTHORITY
Public reporting of KPIs, shareholder compact, 
and targets
˝
˛
˝
˛
˝
˛
˛
n/a
Source: Futuregrowth.

Responsible Investing in Debt Capital Markets: Unpacking Governance for State-Owned Entities 
147
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
persons [PEPs], conflicts of interest). The details of these policies should be investigated 
for suitability.
 
■
Can a single board member or executive alone approve a high Rand-value Rand 
transaction? 
 
■
Under what circumstances can the company do business with a PEP? 
 
■
How are transactions with PEPs reported, managed, and disclosed?
Disclosure and Reporting
The SOEs and corporate entities that raise capital on the Johannesburg Stock Exchange 
(JSE) limited stock exchange (a public capital market) are bound by the South African JSE 
Debt Listings Requirements (DLR). The disclosure and reporting requirements detailed 
in the DLR are weak and need to be improved (e.g., these could include all changes to the 
board and subcommittees, conflicts and PEPs, loans and procurement).
 
■
Disclosure on the Stock Exchange News Service at the time of the event:
o all board and subcommittee member changes and reasons (including new 
appointments);
o details of resumé and experience;
o any identified conflicts; and
o results of probity checks.
 
■
Current and previous director and executive dealings with the company.
 
■
Annual disclosure (website, integrated annual report):
o board and subcommittees: nomination and appointment processes and who the 
decision makers are; and
o charter, terms of reference, mandate, quorum, decision-making requirements 
and authority levels and changes.
 
■
Conflicts of interest policy and PEP policy: 
o application thereof, deviations, remedial action, and any changes.
 
■
Lending: 
o loans made to PEPs, directors, and management.
 
■
Procurement: 
o contracts concluded with PEPs, directors, and management.
Conclusion
Being a responsible investor implies that Futuregrowth makes decisions to allocate capital 
to those sectors and entities that adopt transparent, sustainable policies and practices. We 
recognize that good governance is a key factor to ensure that public entities—mostly funded 
with public money—are sustainably managed for the long term and are able to deliver on 
their developmental mandates. Through this case study, we demonstrated how we assess 
SOEs, illustrated the impact of poor governance in terms of the future outlook for those 
SOEs, strove to raise awareness about these issues, and highlighted the questions investors 
should be consistently asking of all entities that access funding in the public capital markets.

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148
PIMCO
INTEGRATING ESG FACTORS INTO 
SOVEREIGN CREDIT RESEARCH
Lupin Rahman
Traditional sovereign credit analysis focuses on financial and macroeconomic variables 
that materially impact a country’s probability of default and the expected loss if a default 
does occur. Today, it is increasingly apparent that a government’s ability and willingness to 
meet its financial obligations are also influenced by politics, governance, social consider-
ations, natural disasters, and the longer-term impact of environmental factors. The recent 
example of South Africa highlights how integrating environmental, social, and governance 
(ESG) factors into traditional sovereign credit analysis can inform investment decisions 
and potentially help investors safeguard portfolios from large downside risks.
PIMCO’S APPROACH TO ESG 
ESG has been an integral part of PIMCO’s sovereign ratings analysis since 2011 when we 
explicitly incorporated ESG factors into our sovereign ratings model. These ratings are 
complemented by a standalone ESG scoring framework and country-specific scenario anal-
ysis that incorporate ESG risks.  
PIMCO’s proprietary sovereign ratings model starts with an in-depth, bottom-up 
country analysis. This analysis is based on five-year macroeconomic forecasts and specific 
quantitative ESG indicators, and considers both near- and long-term drivers of credit risk. 
ESG variables have a combined weight of approximately 25% in the model. Within ESG, 
governance (“G”) variables dominate, given that they are a leading indicator of sovereign 
risk. Social (“S”) factors, such as health and education, are less directly significant but 
tend to be highly correlated with initial conditions such as gross domestic product (GDP) 
per capita, which, in turn, is highly correlated with sovereign risk. Finally, we have found 
that environmental (“E”) variables on average are the least correlated with three- to five-
year sovereign risk, with the exception of specific incidents (e.g., hurricanes, earthquakes, 
floods, nuclear fallouts). 
We then explicitly score all sovereigns on each ESG component (see Figure 1). Each 
component is weighted equally and the quantitative score is supplemented with qualita-
tive assessments. This allows us to take account of important ESG indicators. For example, 
progress toward the use of renewable energy or an increase in social tensions may not 
necessarily have an immediate impact on sovereign risk but are nonetheless important for 
long-term sustainability.

Integrating ESG Factors into Sovereign Credit Research
149
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
FIGURE 1: VARIABLES INCLUDED IN PIMCO’S ESG SOVEREIGN SCORE
E (ENVIRONMENTAL)
S (SOCIAL)
G (GOVERNANCE)
■Greenhouse gas emissions per 
capita
■The Yale Environmental 
Performance Index
■Fossil fuel usage
■Renewable energy
■GDP per unit of energy 
■Life expectancy
■Mortality rate
■Gender equality
■Gini coefficient (indicates 
wealth distribution)
■Health score 
■Av years of education
■Av years of higher education 
and training
■Labor market indicators
■Corruption indicators
■Political stability
■Voice and accountability
■Rule of law
■Control of corruption
■Government effectiveness
■Regulatory quality
Source: PIMCO.
Finally, our country-specific scenario analysis assesses long-term trends and tail risks. 
We analyze long-term debt sustainability, resource depletion scenarios, natural disaster 
scenarios, political regime change, and contingency risks, incorporating both macroeco-
nomic and ESG factors. Our country-specific scenario analysis helps enable us to identify 
which sovereigns are prone to left-tail risks, which have contingency plans in place, and 
which risks are material for investing. We believe it also gives us a better handle on latent 
risks, many of which tend to be associated with ESG variables.
ENGAGEMENT WITH SOVEREIGN ISSUERS
In-country engagement is a critical component of our sovereign credit analysis and for 
assessing a government’s track record on ESG objectives. During our visits, we gener-
ally meet with senior government officials and politicians, focusing on the details of our 
credit assessment, which range from the composition of the budget and the management 
of foreign exchange reserves and monetary policy to progress on key development and 
environmental goals. We also generally meet with local business people, banks, consul-
tants, trade unions, journalists, nongovernmental organizations, and members of civil 
society to get a broad, holistic sense of developments in the country. The discussions 
tend to be two-way interactions: the government updates us on its progress and plans, 
and our analysts and portfolio managers relay our concerns, assessments, and expecta-
tions to the officials.

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COUNTRY EXAMPLE: SOUTH AFRICA, 2015–2017
Developments in South Africa over the period 2015–2017 reflect how integrating ESG into 
sovereign risk assessment can be used to potentially improve portfolio returns and shield 
portfolios from large downside risks. 
In July 2015, allegations of corruption emerged with regard to former South African 
President Jacob Zuma. Criticism focused on a nuclear energy agreement between South 
Africa and Russia, which was believed to be engineered for President Zuma’s personal 
gain to the detriment of Eskom Holdings SOC Ltd., a South African electricity pub-
lic utility. President Zuma was also accused of having a corrupt relationship with the 
Guptas, a prominent South African business family. A power struggle within the African 
National Congress (ANC) followed, resulting in a weakening of South Africa’s institu-
tional framework, with frequent changes of finance ministers, fiscal slippage, and politi-
cal turbulence. 
When the allegations first surfaced, we initiated a reassessment of South Africa’s polit-
ical and governance risks, and a senior PIMCO team made a due-diligence trip to the 
country. The objective was to understand the economic and institutional impact as well as 
the social consequences of the graft (e.g., the diversion of fiscal resources away from health 
and education). Following in-depth discussions with the government and a detailed analy-
sis, we downgraded our internal credit rating for South Africa, several quarters before the 
major rating agencies did (see Figure 2). The weight of the governance indicators in our 
sovereign ratings, our assessment of the impact of weaker institutions on economic growth, 
and South Africa’s debt burden, and our engagement with senior government officials 
were key drivers of this decision. 
Our downgrade led us to reevaluate our portfolio exposure to South African sov-
ereign and quasi-sovereign risk, and led us to make a call to reduce exposure across 
PIMCO accounts. Due to the integration of ESG factors in our standard sovereign risk 
framework, we were able to identify problems early and reduce exposure when the mar-
kets were still pricing in a favorable scenario for South Africa. Over time, as the extent 
of the corruption became known, the markets and the rating agencies caught up with 
our assessment.
From 2015–2017, we remained engaged with the government and key stakeholders in 
South Africa. This enabled us to better understand the political dynamics and relay inves-
tors’ concerns directly to the key decision makers. Specifically, we emphasized the need for 
improved transparency and governance both within the government and in state-owned 
enterprises—especially in public procurement processes. As global macroeconomic condi-
tions improved, the markets started to reprice South Africa positively, but our negative 
view on governance and transparency led us to remain cautious, particularly as there was 
a good chance that President Zuma’s policies would continue if his ex-wife, Nkosazana 
Dlamini-Zuma, won the leadership of the ANC. With the election of President Cyril

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FIGURE 2: TIMELINE OF SOUTH AFRICA’S SPREADS AND PIMCO’S SOVEREIGN CREDIT 
ASSESSMENT
50
70
90
110
130
150
170
190
210
230
Dec ’14
Jul ’15
Jan ’16
Jul ’16
Jan ’17
Aug ’17
Feb ’18
Spread (bps, Dec ’14 = 100)
CDS Spread
South Africa
EMBI Global
80bps
81bps
Corruption allegations against 
President Zuma
President Zuma 
resigns
2015/2016
PIMCO carries out in depth 
engagement with SA and 
downgrades internal credit 
rating given deterioration 
in the Governance score of 
the country
S&P and Fitch 
downgrade SA 
from BBB to 
BB+ 
Apr ‘17 Jun-Nov ‘17
Downgrades by 
Moody’s (from 
Baa2 to Baa3) 
and S&P (from 
BB+ to BB) 
Source: PIMCO.
Note: The sample is for illustrative purposes only. Past performance is not a guarantee or a reliable indicator 
of future results.
Abbreviations: bps, basis points; CDS, credit default swap; EMBI Global, Emerging Markets Bond Index Global; 
SA, South Africa.
Ramaphosa as leader of the ANC in December 2017 and the exit of President Zuma from 
politics in February 2018, we are monitoring the new government’s progress in correcting 
management gaps in the state-owned enterprise sector and advancing reforms to improve 
governance and transparency. The change in management at Eskom and the procedures 
being put in place to reduce corruption are promising signs that South Africa is finally on 
the long road to recovery.

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ROBECO
TROUBLES IN TURKEY
Max Schieler and Paul Murray-John
Environmental, social, and governance (ESG) criteria factor into our investment process 
via the RobecoSAM Country Sustainability Ranking framework. This ranking evaluates 65 
countries—among which 45 are emerging markets—on a broad range of ESG factors that 
we consider to be relevant from an investor’s perspective. Ranking data are available for all 
countries with a functioning bond market. They include ESG data that one would likely 
expect such as policies on greenhouse gas emissions, human rights, and corruption, but 
also include nontraditional angles such as investments in innovation, labor market unrest, 
or an aging policy.
In selecting the data, we closely cooperate with RobecoSAM (Robeco’s sister company 
that specializes in sustainability investing). Together, we have constructed the ranking and 
selected the 17 factors and more than 200 data series from which the ranking is built. In the 
ESG profile of a country, we emphasize what we find relevant for investment decisions and 
try to identify risks of outsized market losses. Therefore, we add data on items such as gov-
ernment stability, regulatory quality, and energy dependence, and avoid overemphasizing 
factors such as access to electricity (on which nearly all the countries in our universe score 
above 90%). This bottom-up selection process puts more emphasis on social and gover-
nance data, simply because we find these data the most relevant for the investment process.
The output of the ESG analysis is a score for each country in the investment  
universe. This makes it possible to rank countries and to see how their scores evolve over 
time. Changes in the scores and the resulting rank act as a flag for developments that could 
be relevant. For example, Turkey’s score has been red flagged over the past few years.
WEAKENING PUBLIC GOVERNANCE
Turkey’s governance performance and institutional framework have clearly been affected 
by disruptive politics and President Erdogan’s tightening power grip. Instability and unrest 
have been exacerbated by many factors, including an increasingly authoritarian policy 
course, the massive inflow of Syrian refugees, terrorist attacks, Islamic State threats, and 
the alleged end of the peace process with the Kurdistan Workers’ Party. These develop-
ments have also led to a deep divide between the pro- and antigovernment groups that has 
manifested in all spheres of economic, political, and social life—a chasm that is on course 
to widen with time.
The aftereffects of the failed coup in July 2016 are aggravating the already delicate 
political situation. President Erdogan has responded to the failed coup by intensifying his 
long-running purges of police, military, education, business, and political sympathizers

Troubles in Turkey
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© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
(such as the Gülen movement), leaving practically no segment of the public or private 
sphere untouched. Since the coup, the country has been in a state of emergency, in spite of 
initial promises to end this within months. The crackdown will further weaken the coun-
try’s institutions, and its effects are already visible.
The EU Progress Reports of the past few years have noted a relapse in important areas 
such as fundamental civil rights, democracy, press freedom, and rule of law in Turkey. The 
AKP (Justice and Development Party) has also renewed its push for a presidential system 
that would involve a transfer from executive powers to the president. Moreover, President 
Erdogan has confirmed that he will ask parliament to consider reintroducing the death 
penalty as punishment for the plotters behind the failed coup—a step that would be virtu-
ally tantamount to ceding the country’s EU membership ambitions.
PERSISTENT GAPS IN TURKEY’S ESG PROFILE
In our Country Sustainability Ranking, we emphasize governance factors. These factors 
tend to be key drivers of business performance, economic success, and social cohesion. 
This makes the clampdown of Turkey’s institutions all the more tragic. The solidity of the 
governance framework already lags behind all Organisation for Economic Co-operation 
and Development (OECD) countries in terms of perceived quality and will now fall further 
behind its peers. True, some progress has been made in the social area, such as a reduction 
in absolute poverty and improvements in education. However, average household dispos-
able income per capita is still slightly below 50% of the OECD average, working conditions 
are below OECD standards, and income inequality remains high compared with OECD 
peers.
On the social side, gender disparities are pronounced, with low female representation 
in parliament and large gender pay gaps. Turkey’s record on environmental, energy, and 
urbanization issues also compares rather poorly with other OECD countries. Air and water 
quality are far below OECD averages, and greenhouse gas emissions per capita—although 
still fairly low—are rising rapidly. Competition for water across sectors will grow further 
as a result of ongoing urbanization and the increased irrigation needed for agricultural 
expansion. However, positive trends are also visible. Public awareness of environmental 
and climate change issues appears to be rising, and public expenditures in some of these 
areas have been increasing in recent years. Moreover, Turkey is more or less in line with 
EU environmental legislation. But, as is the case with many other emerging economies, 
enforcement is a major weakness because environmental protection is still widely perceived 
as an obstacle to economic development.
Because of these reasons, as of October 2017, Turkey’s rank is 55 out of 65 countries 
we monitor in the RobecoSAM Country Sustainability Ranking—among the bottom 10 
performers. This represents a slide of five spots from September 2013. Currently, there 
is no indication of a turn for the better but rather the risk of further erosion of Turkey’s 
sustainability profile.

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PORTFOLIO IMPACT FOR ROBECO EMERGING DEBT
The decline in the Turkish ESG profile has changed our attitude toward investing in the 
country. The deterioration in the ESG score is not a one-off event; it fits within a negative 
trend. For other countries that have experienced a similar decline in the past (e.g., Brazil), 
this weakness served as a valuable warning signal.
In addition to its weakening ESG profile, Turkey suffers from ongoing weakness in 
the country’s current account, a stubbornly high inflation rate, and increased difficulties 
attracting foreign direct investment. In our opinion, the change in the risk profile of the 
country has not been fully reflected in the valuation of the currency against its peers. We 
have reduced investments in the Turkish lira on several occasions in 2016 and 2017—it has 
been the worst performing currency in the emerging local debt index, depreciating 33% 
versus the US dollar since January 2016.

FIXED-INCOME  
CASE STUDIES:  
MUNICIPAL BONDS

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SAGE ADVISORY SERVICES, LTD. CO.
THE CHALLENGES WITH AND LESSONS 
FROM INTEGRATING ESG ISSUES INTO 
MUNICIPAL BONDS
Nicholas Erickson, CFA
For those looking for investment opportunities stemming from environmental, social, or 
governance (ESG) factors, there is no better place to start than municipal bonds. After all, 
municipalities have been issuing social-impact bonds for decades to support essential com-
munity services, such as public schools, hospitals, affordable housing, and infrastructure 
projects. Over the last five years or so, there has been an increase in projects focused on 
having a greater environmental impact, specifically in mass transit, clean energy, pollution 
reduction, and resource preservation, to name a few.  
What has not been available until recently is the ability to target municipal bonds that 
may offer the greatest impact on the communities they serve. ESG data, used to identify 
investment risks and opportunities that are considered highly likely to affect corporate 
performance and investment performance, are widely available for both equity and fixed 
income securities. Within the municipal bond market, the single greatest challenge is the 
breadth and depth of the issuer pool. With more than 72,000 unique issuers and 950,000 
municipal bond issues, an issue-by-issue ESG evaluation is nearly impossible, and currently, 
no data providers are willing to tackle the issue. To address this challenge, Sage Advisory 
Services partnered with a respected global sustainable data research firm to craft a robust 
framework that allows for the evaluation and scoring of municipal debt through the impor-
tant lens of ESG. 
SAGE’S ESG TAX-EXEMPT FRAMEWORK
Environmental Framework Factors 
Our Environmental Framework is structured around the Green Bond Principles1 of 2016 
and uses the offering statement to determine the use of proceeds and the environmental 
impact of projects. If the project falls within one of the project categories identified in 
Figure 1 and is viewed to be a high- to medium-impact project, it is chosen for further 
evaluation, while low-impact projects are excluded from our investable universe. Examples 
of high- to medium-intensity impact projects include clean energy projects (wind/solar), 
clean mass transit projects (electric rail, public transit), or water conservation projects. 
1 The International Capital Market Association’s voluntary process guidelines that recommend transparency 
and disclosure and promote integrity in the green bond market.

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FIGURE 2: SOCIAL PROJECT CATEGORIES FOR MUNICIPAL BONDS 
Affordable Basic 
Infrastructure  
Affordable Housing 
Employment 
Generation
Food Security
Socioeconomic Advancement and 
Empowerment
The high- to medium-impact projects are then reviewed further to determine whether 
they undergo ongoing third-party verification at the request of the issuer. 
Social Framework Factors
Similar to our Environmental Framework, our Social Framework looks at the use of pro-
ceeds and the intensity of impact the funding is intended to have on the local community. 
First, projects are evaluated to determine if they fall under one of the approved project 
categories and are tiered based on their expected societal impact. Projects that have a 
high- to medium-impact are evaluated for the potential intensity of this impact, while low-
impact projects are excluded. 
Next, we consider the underlying community being served by the project, with an eye 
toward targeting disadvantaged individuals and communities (Figure 2). Demographic 
and economic data are compared to national average thresholds to determine the intensity 
of societal impact. An example of this would entail the evaluation of a municipal issue for 
the construction of a public elementary school. If the percentage of school-aged children 
living in poverty within that school district is greater than the national average, the project 
is determined to have a greater impact intensity on the underlying community.
FIGURE 1: ENVIRONMENTAL PROJECT CATEGORIES FOR MUNICIPAL BONDS
Water 
Energy
Buildings
Transport 
Land-Use
Planning 
Waste
Pollution 
Control

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Governance Framework Factors
Our Governance Framework evaluates general obligation issues by looking at the fiscal 
health and underlying demographic and economic makeup of the issuing city or county. 
When making this evaluation, Sage incorporates a critical analysis of the issues related to 
public pension obligations. We examine the pension plan’s current funded status, annual 
required contribution rate, and the discount rate of the city’s or county’s pension plan, 
and compare them to generally accepted thresholds. If the current funded status is at or 
above the threshold, the annual required contribution is at or above the threshold, and 
the discount rate is at or below the required threshold, the bond issue will be further 
evaluated. If the issue fails on any of these three metrics, it will be excluded from Sage’s 
investment universe. 
For cities and counties that pass the first part of the framework evaluation, their 
underlying communities are further evaluated based on two other metrics—their respec-
tive constituencies’ poverty rates and their median household income. If the poverty rate is 
greater and median household income is lower than the national average, the bond issue 
will be included in our investable universe. 
All five metrics must be met for a municipal issue to pass through the Governance 
Framework. 
MUNICIPAL ISSUE SCORING AND SUSTAINABLE 
DEVELOPMENT GOAL MAPPING
Municipal security issues that undergo this comprehensive framework assessment process 
are then scored on a scale of zero to 100, depending on the impact level of the project and 
the intensity of that impact. Our security selection process is constrained and may only 
include municipal issues that have a minimum score of 50, with medium to high impact 
based on our ESG Framework factors. Next, each security is mapped at the project cat-
egory level to any Sustainable Development Goal(s) and underlying targets with which the 
project shows clear alignment.
Once a security has been reviewed, selected, and identified for inclusion within a client 
portfolio, it is then combined with other securities to create the overall investment portfolio. 
The overall portfolio is then evaluated in terms of its fundamental financial risk characteristics 
(i.e., credit quality, maturity, effective duration, and call features). In addition, the portfolio is 
evaluated in terms of its overall ESG risk characteristics (i.e., ESG factor scores relative to its his-
torical trends, the level of anticipated community impacts, and finally, the expected community 
impact intensity accruing from the projects represented within the portfolio).  
SAGE’S ESG TAX-EXEMPT FRAMEWORK IN ACTION
To illustrate this process of security identification, classification, and Sustainable 
Development Goals mapping, we offer the following analysis of the Aurora, Colorado, 
Water Revenue bond (5%, 8/1/2046) currently rated AA+ (Figure 3). Proceeds of the bond

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FIGURE 3:  ENVIRONMENTAL FRAMEWORK ANALYSIS AND SDG MAPPING OF THE AURORA 
WATER REVENUE BOND
Municipal Bond Issue
Aurora Colorado Water Revenue Green Bond 5% Coupon, 8/1/46
Maturity AA+ Rating, Cusip 051595BC9 
Project Category
Water Treatment
ESG Score: 62.5
Project Impact: 100
Impact Intensity: 25
Target 1
By 2030, achieve universal & equitable access to 
safe and affordable drinking water for all
Target 4
By 2030, substantially increase water-use
efficiency  across all sectors, ensure sustainable
withdrawals & supply of fresh water to address
water scarcity, & substantially reduce the
number of people suffering from water scarcity
Target 1
By 2030, ensure everyone has access to adequate,
safe, affordable housing and to basic services, and 
upgrade slums
6
 CLEAN WATER
 
AND SANITATION
11
 SUSTAINABLE CITIES
 
AND COMMUNITIES
issuance are being used to fund the Prairie Waters Project, which is designed to provide a 
sustainable long-term water supply under drought conditions to Aurora’s growing popula-
tion. Among other benefits, Prairie Waters uses riverbank filtration, a cost-effective natural 
pretreatment process. The project has resulted in more efficient utilization of water sup-
plies and has increased the availability of water by 20%.  
Falling under the Environmental Framework, the project is classified as a water treat-
ment project, focusing on the development, manufacture, and/or installation of tech-
nologies and systems (hardware or software) that increase the efficiency of wastewater 
processing systems and/or improve access to potable water. Based on the use of the pro-
ceeds, the project would have an impact of high and a score of 100. Because the project’s 
use of proceeds is fully dedicated to the eligible project but the issuer has not had an 
independent third party evaluate the ESG characteristics of the project, the impact inten-
sity of the project would be rated a medium and assigned an impact intensity score of 25. 
Combining these two metrics generates an overall score of 62.5 and an overall impact level 
of medium.

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INTEGRATING THE ESG TAX-EXEMPT FRAMEWORK 
INTO CREDIT ANALYSIS 
By adding the ESG analysis to a typical credit analysis, we can obtain a more complete 
picture of not only the current health of the municipal issuer but also any future potential 
complications. When droughts occur in areas where water treatment systems are not effi-
cient and cost effective, municipalities will typically need to institute water use restrictions. 
By restricting the population’s water use, the utility is, in effect, restricting its own source 
of revenue. When combining reduced revenue with higher costs and project budgets mod-
eled on higher revenue targets, these municipalities’ finances can be stressed, thus leading 
to a deterioration of their underlying credit characteristics.  
With Aurora’s water system set up for increased water use efficiency in times of 
drought, it should be better equipped to weather a drought, both from a financial and a 
water use standpoint. This is also reflected in the outlooks provided by the credit-rating 
agencies. Upon affirming the issue’s AA+ rating, Fitch Ratings Inc. noted that the Aurora 
water system had “strong financial, resource planning; [their] comprehensive long-term 
financial, capital, and water supply planning practices have positioned operations well and 
provide a strong enhancement to credit quality.”  
Overall, factoring in the ESG analysis when doing a full credit analysis not only helps 
the investor identify potential areas of hardship that a municipal issuer might go through, 
but it can also help highlight municipal issuers that have a longer-term, more stable credit 
profile.

FIXED-INCOME  
CASE STUDIES: 
STRUCTURED CREDIT

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ANGEL OAK CAPITAL ADVISORS, LLC
ASSESSING ESG FACTORS IN  
STRUCTURED SECURITIES
Linda H. Singer, Robert McDonough, Liang “Leo” Guo, and Ethan Reback
The issuance of green asset-backed securities (ABS) almost quadrupled from $8.6 billion 
in 2016 to $36 billion in 2017,1 but significant challenges remain in quantifying the environ-
mental, social, and governance (ESG) factors in a portfolio comprising more traditionally 
structured securities. Angel Oak Capital Advisors, LLC (AOCA) is an investment man-
agement firm with a focus on structured securities, including residential and commercial 
mortgage-backed securities (RMBS and CMBS), collateralized loan obligations (CLOs), 
and collateralized debt obligations (CDOs). In addition, AOCA has direct experience with 
seven RMBS and one CDO backed by US community-bank debt. AOCA is in the process 
of developing an internal ESG scoring methodology for ABS. This case study summarizes 
the challenges that have been identified as well as the progress made in implementing the 
methodology.
Publicly traded equity and debt securities are typically issued by a single entity that 
provides the basis for standardized, formulaic ratings of its ESG performance, both histori-
cally and versus its industry peers. Securitized instruments consist of pools of assets where 
both the issuer/sponsor of the security (Issuer) and the issuer of the underlying assets 
(Asset Issuer) are often private. Figure 1 details the components of a representative AOCA 
portfolio.
ANALYZING AND INTEGRATING ESG FACTORS IN 
STRUCTURED CREDIT PORTFOLIOS
Historically, AOCA has conducted rigorous due diligence on all potential asset pur-
chases, focusing on determining the financial risk/return characteristics of the instru-
ments. This assessment includes a review of performance and risk metrics (e.g., earnings, 
nonperforming loans, loss reserves, and capital adequacy) for each issuing institution, 
indicating the probability of default for each instrument. AOCA’s rationale for including 
ESG factors in the investment process includes studies indicating that institutions with 
high ESG scores are:
■
■
more competitive, thereby generating abnormal returns, leading to higher profit-
ability and dividend payments;
1 Dennis Badlyans. 2018. “Green Bond Issuance Doubled in 2017.” https://seekingalpha.com/
article/4157445-green-bond-issuance-doubled-2017

Assessing ESG Factors in Structured Securities 
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FIGURE 1: REPRESENTATIVE STRUCTURED CREDIT PORTFOLIO HOLDINGS AS 
OF 30 MAY 2018
NUMBER  
OF 
SECURITIES/ 
CUSIPS*
NUMBER  
OF  ISSUERS
NUMBER  
OF 
TRUSTEES
NUMBER  
OF 
UNDERLYING 
ASSETS
AVG. 
NUMBER OF 
UNDERLYING 
ASSETS PER 
CUSIP
COLLATERAL POOL 
DESCRIPTION
ABS
28
21
8
N/A**
N/A**
Static pool of similar 
receivables  from a single 
creditor or aggregated 
creditors including  auto/
credit cards/student loans
Agency 
CMBS
22
5
4
1,290
58
Static pool of primarily 
multifamily commercial 
mortgages
CLO
58
38
6
16,691
287
Actively managed pools of 
public & private corporate 
loans
CMBS
99
30
6
4,111
42
Static pool of either a 
single asset or conduit 
deal containing a pool of 
commercial real estate 
properties where the top 10 
loans typically comprise  
40–55% of the notional
Nonagency 
RMBS
707
97
9
1.83 million
2,563
Static pool of residential 
mortgages
Grand Total
931
205
15**
2.07 million
* Corporates, derivatives, and cash excluded from fund portfolio holdings. 
** Number of ABS underlying receivables ranged from 6k to 78k for Auto ABS and up to 82k for Credit Card ABS.
*** 15 unique Trustees across 931 CUSIPs.
 
■
better at managing company-specific business and operational risks, lowering 
the probability of suffering incidents that can negatively impact their share price; 
and
 
■
less exposed to systemic risk factors, lowering their expected cost of capital.2
2 Guido Giese. 2018. “Has ESG Affected Stock Performance?” https://www.msci.com/www/blog-posts/
has-esg-affected-stock/0794561659

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Portfolio managers will provide an assessment of the impact of ESG scores on the 
investment selection process once internal ESG metrics are established by investment 
product. The ESG scores for each portfolio will be tracked and reported to relevant stake-
holders. Portfolio managers will be responsible for ensuring that each fund’s ESG scores 
trend higher than the initial baseline.
METHODOLOGY AND CHALLENGES TO CALCULATING 
ESG SCORES
ABS are issued through structured credit special-purpose vehicles (SPVs). SPVs create 
debt and equity tranches whose value derives from the income generated by the asset pool 
underlying the SPV. Although deal structures vary, they typically involve multiple banks, 
broker/dealers, and SPVs having the roles of trustees, collateral managers, issuers, ser-
vicers, and depositors (Transaction Parties). ESG assessments can be conducted at two 
levels—Transaction Parties and Asset Issuers—and on the underlying assets of the SPV. 
AOCA’s goal is to develop an internal methodology that will be utilized to monitor its port-
folios until an industry-accepted methodology becomes available.
Transaction Party Level
AOCA has experienced several challenges in collecting data for ESG assessments and 
implementing ESG practices at the Transaction Party level:
1. Although the US Treasury now requires trustees to verify the identities of benefi-
cial owners of their clients’ SPVs,3 this information is not public. 
2. Holders of the debt securities (creditors) issued by SPVs do not have an owner-
ship interest in the SPV, which results in one less data point for AOCA to evaluate 
because proxy votes aren’t relevant.
3. As detailed in Figure 1, the number of Transaction Parties is small compared with the 
number of Asset Issuers. Securities with underlying assets from aggregated creditors 
would have different evaluation criteria from those with assets of a single creditor. 
Despite these challenges, AOCA continues to engage with the industry to develop a 
methodology that assigns a weighted ESG score to Transaction Parties and Asset Issuers.
Underlying Asset Level
Vendor databases maintain cash flow data for structured securities and store details on 
the underlying assets as provided by the trustee and/or collateral manager, although 
not all data items are populated and/or available for download. In addition to cash flow 
3  One World Identity. 2018. “FinCEN Clarifies Customer Due Diligence Rules as May Compliance Deadline Looms.” 
https://oneworldidentity.com/fincen-clarifies-customer-due-diligence-rules-may-compliance-deadline-looms/

Assessing ESG Factors in Structured Securities 
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FIGURE 2:  COMPARISON OF AVAILABLE INFORMATION FOR CLOS FROM TWO DATABASES
DATABASE A
DATABASE B
SPV CUSIP
UNDERLYING ASSET 
CUSIP
SPV CUSIP
UNDERLYING ASSET 
CUSIP
Underlying Asset Count
94%
N/A
100%
N/A
CUSIP
100%
81% (+3% Invalid)
N/A
89%
Industry
N/A
81%
N/A
91%
Domestic vs. International
2% Domestic
77% Domestic
N/A
94% Domestic
Published ESG Score
0%
15%
0%
0%
Issuer
100%
81%
100%
100%
Trustee
100%
N/A
100%
N/A
Lead/Collateral Manager
100%
N/A
100%
N/A
information, the databases may include the Committee on Uniform Security Identification 
Procedures (CUSIP) numbers, International Securities Identification Numbers, and 
LoanX IDs (a unique identifier applied to syndicated loans), industry codes, credit rat-
ings, and other descriptors (see Figure 2). ESG scores are more likely to be available at the 
underlying asset level when the Asset Issuers are publicly held companies. Even when the 
relevant information is available in a database, it is not always in a readable format that 
can be easily extracted. For example, underlying asset schedules had to be downloaded 
individually to perform a more detailed analysis of a sample of 26 CLOs, of which 84% of 
the Asset Issuers were able to be mapped to equity tickers, which are more likely to have an 
ESG score. 
Additional information related to the underlying assets (such as commercial tenants, 
geographical locations, income, and industry concentrations) can be manually extracted 
from prospectuses and other offering documents. Formats vary and because many of 
the Transaction Parties are frequently private funds and/or SPVs, the prospectus and/
or offering memorandum are often the only source for factors that would facilitate the 
calculation of ESG scores. The creation of common naming conventions would facilitate 
the capture of ESG-relevant factors using optical character recognition software. Ideally, 
ESG-related factors such as Leadership in Energy and Environmental Design certifica-
tion, ESG-positive industries, and corporate board diversity could be added to existing 
portfolio concentration tables as additional reference material. The ESG value of these 
data would then be assigned to each underlying asset’s contributed balance as a percent-
age of the total SPV notional to develop a weighted-average ESG factor for the SPV.

Guidance and Case studies for ESG Integration: Equities and Fixed Income
WWW.CFAINSTITUTE.ORG
166
PROPOSED METHODOLOGY TO INCORPORATE 
ESG FACTORS
AOCA has recently begun to collect potential ESG assessment factors as part of its due dili-
gence process when investing in community-bank subordinated debt. These investments 
are held in portfolios managed by AOCA; some have been included in CDO securitiza-
tions. Portfolio managers conduct phone interviews with senior management at the issuing 
banks and often schedule onsite meetings when feasible. These interactions provide an 
opportunity to identify ESG factors such as: 
■
Community Development Entity certification, allowing participation in New 
Market Tax Credit programs that provide loans to immigrant and disadvantaged 
communities;
■
Community Development Financial Institution (CDFI) designation, recognizing 
banks that specialize in serving economically distressed communities;
■
loans to industries (e.g., solar energy, low-income housing, and waste manage-
ment/recycling) that have positive environmental and societal benefits;
■
Small Business Administration (SBA) 7(a) loans to local companies that support 
job creation;
■
directors or associates who serve on the boards of nonprofit organizations; and
■
activities that satisfy Community Reinvestment Act (CRA) requirements:
o affordable housing loans to low-to-moderate income borrowers,
o loans to businesses in economically distressed areas,
o lending to support natural disaster recovery efforts,
o student lending programs, and
o lending to support nonprofits, foundations, and government agencies.
These factors are aligned with the United Nations’ Sustainable Development Goals as 
shown in Figure 3. 
AOCA has begun capturing these data in its due diligence questionnaire, which 
will be used to gauge the ESG factors in community-bank subordinated debt instru-
ments. These investments frequently become collateral in bank subordinated debt 
CDO securitizations, and their ESG factors can be used to create an asset-weighted 
average ESG score for the CDO. Although these ESG scores can be used by potential 
investors to evaluate CDOs, the ability to compare scores across different sponsors 
will ultimately require some degree of industry standardization. Figure 4 details fac-
tors impacting ESG associated with representative community-bank subordinated debt 
held in portfolios managed by AOCA by percentage of notional. Utilizing the CRA, 
CDFI, and SBA data as factors to create an ESG score for the portfolio resulted in a 
baseline of 35% positive impact for the holdings.

Assessing ESG Factors in Structured Securities 
167
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
FIGURE 3: SAMPLE CDO ESG FACTORS MAPPED TO THE UNITED NATIONS’ SUSTAINABLE 
DEVELOPMENT GOALS
Community 
Reinvestment
Act 
Rating
Community 
Development 
Financial 
Institutions
Small Business 
Administration
7(a) Lender
Commercial & 
Consumer Loan 
Composite
Diversity of
Board & 
Officers

Guidance and Case studies for ESG Integration: Equities and Fixed Income
WWW.CFAINSTITUTE.ORG
168
FIGURE 4: FACTORS THAT IMPACT ESG FOR COMMUNITY-BANK SUBORDINATED DEBT
Needs to Improve
1%
Community Reinvestment Act Rating
Outstanding
17%
Satisfactory
82%
16%
84%
Top 100 most active 
SBA 7(a) lenders, 
Jobs Supported, 
213,329 
Others, 
Jobs
Supported,  
144,927
Top 100 Most Active SBA 7(a) Lenders
(Inner Circle) & 
Jobs Supported through SBA Programs
Since 2011 (Outer Circle)
Certified CDFIs
4%
Certified CDFIs
ESG Impact of Portfolio
Others
96%
64%
32%
3%
Above Average
1%
Average
Below Average
Outstanding

Assessing ESG Factors in Structured Securities 
169
© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.
OPPORTUNITIES FOR ENHANCED ESG ASSESSMENTS
The following points would facilitate evaluation of ESG factors as investors conduct due 
diligence on potential investment decisions for structured financial instruments (particu-
larly CDOs):
■
market consensus on ESG factor weights for Transaction Parties and Asset Issuers 
by product;
■
standardization of ESG factor reporting by Issuers in offering memorandums/
prospectuses, including data on nonindividual SPV beneficial owners and nonpublic 
Issuers;
■
coordination among database administrators to publish ESG-related factors; 
■
implementation of an ESG factor rating system for CDO transactions; and
■
incorporation of ESG data associated with equity securities of the issuing bank 
into the CDO rating.
Other firms can use a similar methodology for structured securities, but until the 
industry agrees to a standard methodology for each product to ensure comparability 
across individual firms’ ESG metrics, investors can compare AOCA’s ESG impact only to its 
own  historical record.

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