ESG factors can serve as key indicators of investment risk.
Environmental, Social and Governance standards have long been integral inputs into our security analysis.
Here’s how we underwrite ESG in the investment process.
Cohen & Steers is committed to investment excellence and delivering superior long-term returns to our clients. Consistent with this objective, fundamental analysis is the foundation of our investment process, grounded in a combination of a top-down and bottom-up analysis for assessing relative value and total return potential. As part of this analysis, we identify risks and opportunities that may impact a company’s performance.
Importantly, we believe ESG factors can influence our evaluation of a security’s expected total return. Our assessment of corporate governance is at the forefront of our fundamental analysis. In addition to providing a foundation for value creation and total return performance, we believe strong governance is critical to driving sound environmental and social practices and achieving sustainable business models. Furthermore, we believe companies that integrate ESG considerations into their strategic plans and operations can enhance long-term shareholder value while mitigating potential risks.
At Cohen & Steers, we review each company in our investment universe across environmental, social and governance (ESG) factors specific to the unique dynamics of its industry and asset class. Our size and depth of expertise, along with the frequency of our company interactions, allows us to carefully assess management credibility and strategy. We combine these insights with third-party data to form a comprehensive view that is expressed both explicitly and implicitly in our investment decisions. Our integration process is segmented into the following four steps:
- Identify ESG factors and assign weights by asset class sectors.
- Generate proprietary ESG scores.
- Integrate scores into investment decision.
- Engage companies to gain insight and drive positive change.
1. Identify ESG factors and assign weights by asset class sector
Different asset classes tend to have distinct “cores” for extracting and realizing value. For example, real estate is a capital allocation business, elevating the importance of governance. By contrast, some industries within natural resource equities and infrastructure can be more operations focused, where safe working conditions are a matter of life and death.
Therefore, the first step in our process is to define the key E, S and G factors that are most relevant to sectors within each asset class. We quantify these issues by assigning a sector-specific weight to each factor based on our extensive knowledge of the asset classes, combined with third-party research. This begins with data from MSCI, a leading ESG research provider with broad coverage of the companies in our target asset classes, providing what we view as a good starting point for overlaying our proprietary analysis.
Key governance issues tend to apply broadly across sectors and asset classes. These include:
- Management acumen
- Board structure, tenure, refreshment, alignment
- Shareholder rights
- Executive compensation
- Audit and risk oversight
- Insider/management ownership and shareholder structure
- Systemically important financial risk (specific to preferred securities and infrastructure)
- Corruption and political/social instability (specific to natural resource equities)
By contrast, environmental and social factors tend to vary meaningfully across sectors, demanding a customized approach to ESG integration across our strategies.
Key environmental and social factors by asset class
- Green building opportunities
- Energy management
- Green bond issuance
- Waste management
- Water management
- Green leases
- Physical climate impacts
- Human capital management
- Diversity and inclusion
- Health and wellness
- Community impact
Infrastructure and Midstream Energy
- CO2 emissions, costs of associated credits
- Physical climate impacts
- Subsidies for green power offtake, risks to environmental policies and regulation
- Water stress, land use
- Nuclear liabilities
- Customer satisfaction scores, staff training programs and sponsorships
- Service interruption, operational safety, employees’ incidence rate
- Initiatives to support customers in financial need
- Data security
Natural Resource Equities
- Robust operations with safeguards for unforeseen events
- New technology developments which create risks/opportunities for fossil fuels
- Proper handling of waste materials/water used in the production process
- Gender pay gaps, complex political and social issues in developing countries where possible investments can be located, specifically in the Metals & Mining sector
- Climate change vulnerability
- Financing environmental impact
- Human capital management
- Privacy data and security
- Financial product appropriateness
- Responsible Investment
- Insuring health and demographic risk
- Providing financing to underserved markets
- Climate change
- Scarcity of finite resources
- Human rights
- Working conditions
- Impacts on local/indigenous communities
2. Generate proprietary ESG scores
Using the factors determined above, we generate ESG scores for each company relative to its industry. MSCI’s ESG scores serve as a starting point, and analysts then adjust these scores where necessary based on our proprietary research. Resources for making these adjustments include other respected ESG research providers (ISS, Sustainalytics, RobecoSam), sell-side research reports, company flings, Bloomberg metrics and, our most significant driver of scores, our interaction with company management. Scores are typically assessed on a quarterly basis, but may be adjusted more frequently if there are material changes in circumstances.
Our proprietary overlay is a key diﬀerentiator of our approach to ESG integration, as we leverage the depth and scale of our platform and scope of our information gathering to enhance third-party research. Accordingly, we actively encourage our analysts to make appropriate wholesale adjustments as necessary when using external ratings, focusing on companies’ more strategic versus temporary actions.
3. Integrate scores into investment decisions
Our investment teams incorporate ESG risks and opportunities into the fundamental research process by implicitly and explicitly integrating our ESG scores into investment decision making. Due to the inherent differences in valuation approaches by asset class, ESG scores are integrated in distinct ways, as shown below.
Customizing ESG score integration by asset class
Real Estate, Infrastructure, Midstream Energy, and Natural Resource Equities
- Adjust cash flow forecasts and discount rates to reflect risks
- Incorporate into relative value analysis, assigning premiums for weak ESG scores and discounts for strong scores
- May impact level of ownership and some issuers may be deemed uninvestable
- Align with commodities ESG best practices (such as not taking physical delivery and avoiding investment in rare earth or minor metals) to promote well-functioning markets
At August 31, 2020. Source: Cohen & Steers.
4. Engage companies to gain insight and drive positive change
We take an active ownership and engagement approach with companies in our investment universe, advocating for sound ESG principles that we believe can help optimize investment performance.
This engagement is an integral part of our fundamental research process, providing a framework for dialogue between us and our portfolio companies, inﬂuence or change a company’s ESG practices in ways that we believe may have a material impact on its ability to preserve or grow its economic value.
Our engagement process involves four main components:
Our primary method involves direct dialogue with senior management or boards of directors. This can be a particularly effective tool when we hold a significant ownership position.
We take an active approach to proxy voting based on our view that our investment professionals—not third-party service providers—have the best insight into our portfolio companies and are best-positioned to vote proxies on behalf of our clients. Our proxy voting decisions take ESG factors into consideration and seek to protect our clients’ long-term economic interests.
In certain instances, we may collaborate with other investors and stakeholders, where appropriate and permitted by applicable law and regulation, to ensure that companies protect the rights of all shareholders and consider how actions may impact all stakeholders.
To encourage companies to adopt ESG best practices at an industry level, we work with industry associations, including:
- Principles for Responsible Investment (signatories since 2013)
- GRESB (formerly “Global Real Estate Sustainability Benchmark,” the organization now also covers infrastructure)
- European Public Real Estate Reporting & Accounting Committee
This work fosters collaboration and allows us to discuss and assess ESG matters with industry peers and leading industry constituents.
This ongoing engagement helps us understand risks and opportunities and adjust our proprietary valuations to refine our investment decisions. In addition, we utilize engagement to encourage companies to improve transparency and disclosure, as well as make better business decisions. We believe these discussions can lead to strategic decisions that may enhance financial and operating performance, reduce the risk of reputational damage and improve long-term shareholder returns.
What distinguishes our approach to ESG?
We believe the size and experience of our investment teams, together with the frequency and depth of their interactions with companies, enable a deep understanding of management credibility and strategy, allowing us to assess material ESG considerations beyond the scope of third-party research firms.
Our leadership position in listed real assets and alternative income amplifies our voice and inﬂuence when we engage with companies—whether we currently invest in them or not. We believe this helps our ESG advocacy have maximum impact.
ESG integration at Cohen & SteersWatch video
At Cohen & Steers, we review each company in our investment universe across environmental, social and governance (ESG) factors specific to the unique dynamics of its industry and asset class. Managing analyst Raquel McLean chairs our ESG Investment Committee and shares our four-step process to integration.
Proprietary ESG scores and our approach to engagementWatch video
Our analysts go beyond third-party scores, weighing individual factors against our proprietary scoring model. This hands-on approach extends to our engagement with firms, as Cohen & Steers does not rely on third-party proxy services. Members of our ESG Investment Committee share why they feel this differentiates us and how it gives us an advantage.
Biden, energy and the future of ESG investingWatch video
Members of our ESG Investment Committee look ahead to the themes that will affect the future of ESG investing, including the impact the Biden administration could have on infrastructure and the energy sector.
Weighing environmental and social factors in infrastructure investingWatch video
While Governance factors tend to be consistent across sectors, the Environment and Social factors vary. Portfolio manager Quynh Dang breaks down the unique factors that apply to infrastructure and how the team approaches them.
There is no guarantee that any historical trend illustrated herein will be repeated in the future, and there is no way to predict precisely when such a trend will begin. There is no guarantee that any market forecast made in this document will be realized. The views and opinions in the preceding document are as of the date of publication and are subject to change without notice. An investor cannot invest directly in an index and index performance does not reﬂect the deduction of any fees, expenses or taxes. Index comparisons have limitations as volatility and other characteristics may differ from a particular investment. This material represents an assessment of the market environment at a specific point in time and should not be relied upon as investment advice, does not constitute a recommendation to buy or sell a security or other investment and is not intended to predict or depict performance of any investment. This material is not being provided in a fiduciary capacity and is not intended to recommend any investment policy or investment strategy or take into account the specific objectives or circumstances of any investor. We consider the information in this material to be accurate, but we do not represent that it is complete or should be relied upon as the sole source of appropriateness for investment. Cohen & Steers does not provide investment, tax or legal advice. Please consult with your investment, tax or legal professional regarding your individual circumstances prior to investing.
Risks of Investing in Real Estate Securities. The risks of investing in real estate securities are similar to those associated with direct investments in real estate, including falling property values due to increasing vacancies or declining rents resulting from economic, legal, political or technological developments, lack of liquidity, limited diversification and sensitivity to certain economic factors such as interest rate changes and market recessions.
Risks of Investing in Global Infrastructure Securities. Investments in global infrastructure securities will likely be more susceptible to adverse economic or regulatory occurrences affecting global infrastructure companies than an investment that is not primarily invested in global infrastructure companies. Infrastructure issuers may be subject to regulation by various governmental authorities and may also be affected by governmental regulation of rates charged to customers, operational or other mishaps, tariffs, and changes in tax laws, regulatory policies, and accounting standards.
Risks of Investing in Foreign Securities. Foreign securities involve special risks, including currency ﬂuctuations, lower liquidity, political and economic uncertainties and differences in accounting standards. Some international securities may represent small- and medium-sized companies, which may be more susceptible to price volatility and less liquidity than larger companies.
Risks of Investing in MLP Securities. An investment in MLPs involves risks that differ from a similar investment in equity securities, such as common stock, of a corporation. Holders of equity securities issued by MLPs have the rights typically afforded to limited partners in a limited partnership. As compared to common shareholders of a corporation, holders of such equity securities have more limited control and limited rights to vote on matters affecting the partnership. There are certain tax risks associated with an investment in equity MLP units. Additionally, conﬂicts of interest may exist among common unit holders, subordinated unit holders and the general partner or managing member of an MLP; for example a conﬂict may arise as a result of incentive distribution payments.
Risks of Investing in Commodities. An investment in commodity-linked derivative instruments may be subject to greater volatility than investments in traditional securities, particularly if the instruments involve leverage. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates, or factors affecting a particular industry or commodity, such as drought, ﬂoods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. The use of derivatives presents risks different from, and possibly greater than, the risks associated with investing directly in traditional securities. Among the risks presented are market risk, credit risk, counterparty risk, leverage risk and liquidity risk. The use of derivatives can lead to losses because of adverse movements in the price or value of the underlying asset, index or rate, which may be magnified by certain features of the derivatives.
Futures Trading Is Volatile, Highly Leveraged and May Be Illiquid. Investments in commodity futures contracts and options on commodity futures contracts have a high degree of price variability and are subject to rapid and substantial price changes. Such investments could incur significant losses. There can be no assurance that the options strategy will be successful. The use of options on commodity futures contracts is to enhance risk-adjusted total returns. The use of options, however, may not provide any, or may provide only partial, protection for market declines. The return performance of the commodity futures contracts may not parallel the performance of the commodities or indexes that serve as the basis for the options they buy or sell; this basis risk may reduce overall returns.
Risks of Investing in Natural Resource Equities. The market value of securities of natural resource companies may be affected by numerous factors, including events occurring in nature, inﬂationary pressures and international politics.
Risks of Investing in Preferred Securities. Investing in any market exposes investors to risks. In general, the risks of investing in preferred securities are similar to those of investing in bonds, including credit risk and interest-rate risk. As nearly all preferred securities have issuer call options, call risk and reinvestment risk are also important considerations. In addition, investors face equity-like risks, such as deferral or omission of distributions, subordination to bonds and other more senior debt, and higher corporate governance risks with limited voting rights. Below investment-grade securities or equivalent unrated securities generally involve greater volatility of price and risk of loss of income and principal, and may be more susceptible to real or perceived adverse economic and competitive industry conditions than higher grade securities. Benchmarks may not contain below-investment-grade securities.
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