Integrating ESG into valuation models and investment decisions: the value-driver adjustment approach

ABSTRACT

True Environmental, Social and Governance issues (ESG) integration means ESG factors are systematically fed into the valuation models and investment decisions of analysts and portfolio managers (PMs). However, most ESG approaches fail to do this. As a result, sustainable investing is much less an application success than a marketing success. Our Value-Driver Adjustment approach is different: it ties into traditional valuation approaches by linking ESG issues to value drivers via their impact on business models and competitive positions. For equities, the initial results find that the average target price impact of ESG factors is 5% overall, and 10% conditional on non-zero adjustments; dispersion is wide as target price changes ranged from −23% to +71%. The investment team has experienced a pay-off in terms of more in-depth analysis of companies, a clearer view on risk and better informed decisions.

KEYWORDS:

• Sustainable investing
• ESG integration
• equities investing
• materiality
• valuation

Acknowledgements

The author wishes to thank two anonymous reviewers for their valuable feedback.

Disclosure statement

No potential conflict of interest was reported by the author.

ORCID

Willem Schramade http://orcid.org/0000-0003-2004-4409

Notes

1 Our approach focuses on valuation impact since we are shareholders, and hence residual claimholders: most extra costs and benefits to the firm hit shareholders. The main exceptions are externalities, but they are increasingly internalized (see e.g. True Price 2014). We therefore keep a close eye on the outcomes of true price analyses, as they identify key areas of concern.