Scientific Beta

This overview paper describes Scientific Beta's ESG integration approach, reviews the global norms supporting the ESG Fiduciary Option and details its screens. It also presents the ESG profile and financial risks and performances of representative ESG multi-smart factor indices.

The incorporation of environmental, social and governance (ESG) dimensions into investment management has traditionally been associated with values-based and socially responsible investment (SRI), whose footprint in the investment management industry long remained relatively modest. However, assets managed with consideration of ESG dimensions have grown massively in the last 15 years, topping USD30 trillion in main markets by the beginning of 2018 (GSIA, 2019), and ESG incorporation is increasingly practiced by mainstream investors.

This evolution is driven by both pull and push factors. On the one hand, institutional investors are increasingly required, or expected, to explain how they factor ESG dimensions into investment decisions and to report on their ESG incorporation processes and the ESG performance of their investments. On the other hand, it is becoming conventional wisdom in the investment industry that the ESG characteristics of investments may have a material impact on the financial risks and returns of portfolios, particularly in the long run, and that ESG incorporation is thus required of responsible fiduciaries aiming for sustainable long-term returns. There is also an increasing share of end investors wishing to see the environmental and social impacts of their investments considered together with (or ahead of ) their financial characteristics.

Business-case investors incorporating ESG dimensions with a view to strengthening risk management or enhancing returns are joining traditional values-based and socially responsible investors in imposing non-financial constraints and/or objectives to align their investments with personal values or social norms and seek positive ESG impact. The motivations for incorporating ESG data into investment management have never been so diverse.

Scientific Beta recognises the diversity of these motivations and its ESG and Low Carbon Fiduciary Options as well as its Enhanced ESG Reporting are designed to serve a broad cross-section of investors.

The ESG Fiduciary Option is applicable across Scientific Beta’s entire flagship multi-factor index offering. It implements screening in respect of corporate conduct and activities which is grounded in international norms and corresponds to consensus themes. Exclusions may be motivated by a deontological motive to dissociate from unethical products and conducts. They may also be driven by a consequentialist approach, seeking to bring about positive change by incentivising ethical behaviour or transition towards responsible activities on the part of shunned and other companies. Exclusions may also be motivated by self-interest as they reduce the reputational and liability risks involved with supporting companies and activities that fail global standards and also remove companies whose ESG characteristics entail a risk of material negative impact on the financial performance of the portfolio. This includes companies that could be most negatively affected by ESG-related systematic changes owing to their controversial activities as well as those that could be especially prone to future idiosyncratic value-destroying ESG events and controversies due to their past and current controversial behaviour.

As such, the ESG Fiduciary Option is relevant to values-based and socially responsible investors who wish to dissociate from companies that contravene global norms or who seek to promote the respect of these norms. It is also relevant to those business-as-usual investors seeking financial outperformance and who wish to mitigate reputational and liability risks or avoid ESG risks with potential adverse financial materiality.