What are “Portfolio ESG Metrics”?
Portfolio ESG metrics measure and describe the environmental, social, and governance characteristics of a fund. As ESG becomes increasingly prevalent in the market, portfolio ESG metrics are attracting interest from a range of stakeholders.
Portfolio ESG metrics can be done on a calculated basis such as the carbon intensity of a fund or on the basis of a rating. These portfolio ESG metrics can be used to benchmark the fund against that of a peer group which can be particularly useful for stakeholders.
Key Learning Points
- A portfolio ESG score shows the overall rating of the fund in a single measure that captures environmental, social, and governance characteristics of the fund
- Portfolio overall ESG scores or environmental, social and governance characteristics measured separately may be compared to those of a benchmark or other funds in the peer group
- Carbon intensity of a fund measures emissions relative to the output of the companies in the portfolio and is usually expressed as the amount of CO2 emissions in tons per $1m of sales
- Portfolio carbon intensity may be compared to that of a benchmark or peer group
ESG Metrics of a fund
Asset managers and their clients may want to understand how sustainable the fund is or just how well the fund scores on ESG matters in general. The ESG-related funds would typically supplement the traditional metrics such as portfolio return and risk with portfolio ESG metrics.
A portfolio ESG score shows the overall rating of the fund in a single measure that captures the environmental, social, and governance characteristics of the fund. It may be based on an internally developed scoring system or may be based on a scoring system used by a commercial ESG rating provider. The overall score may be expressed as a rating on a scale of 0 to 100, or by a letter-based rating, with AAA being the highest and CCC being the lowest. Regardless of which system is used, if other funds’ ESG ratings are calculated using the same methodology, portfolios’ ESG attributes can be compared with one another. Alternatively, the portfolio’s ESG score can be compared to that of its benchmark.
Understanding a portfolio’s environmental attributes such as carbon footprint has become one of the most common steps in fund analysis. There are several ways of expressing fund carbon metrics. One is to calculate the total carbon emissions generated by the portfolio. If a fund owns 1% of a company, then it will be responsible for 1% of the investee company’s total CO2 emissions in a year. The total carbon footprint is then calculated by adding up the fund’s share of the CO2 emissions of all the companies in the fund.
Funds are also increasingly eager to understand the social impact of their investments. There are numerous metrics that can be used to build a better understanding of how the companies in the portfolio ensure fair treatment of human capital. Human rights, consumer protection, and even animal rights are some of the many possible social metrics.
Governance metrics are used to understand the manner in which the companies in the portfolio are run and managed. The aim of these metrics is to provide an indication of how the companies in the portfolio treat and manage their employees. Contributing factors could include board integrity, discrimination, and executive vs. employee compensation.
Example- Calculating Carbon Intensity of Fund
In the below example, we have been asked to calculate the weighted average carbon intensity of the fund. We have been given the weighting of each company in the fund, the annual scope 1 & 2 emissions, the total sales and the carbon intensity of each company.
The weighted average carbon intensity of the fund is calculated as follows:
The overall fund metric of 103 tons per $1m of revenue, can then be compared to the intensity figure for other funds or a benchmark. This figure can also be monitored over time to see how the fund is performing on a historic basis.
One drawback to the above example is, we not only need to know what the portfolio holdings are and their weights, but we also need to obtain carbon emissions data on the companies in the portfolio. And we also need to obtain the same data for a benchmark or the peer group of funds.
The above measures are static measures that capture the overall ESG position of the fund based on the constituent’s attributes at a point in time. More sophisticated approaches would monitor how the fund metrics evolve over time, or how much progress the companies held by the fund make toward better managing their ESG risk or in their efforts to decarbonize.
Several metrics can be used to describe the overall environmental, social, and governance characteristics of a portfolio. They can be done on the basis of a rating for example from 0 to 100 or on a calculated basis such as calculating the carbon intensity of a fund. Portfolio ESG Metrics are typically used by clients and analysts, to compare the fund to its benchmark, fund in the peer group or to track the fund manager’s progress over time.