How Linear Establish an ESG Rating

ESG is the acronym of the moment. Here Linear explains how they establish an ESG rating for their DFM portfolios

ESG is an umbrella term for investments that seek to achieve positive returns alongside creating long-term lasting change and impact on the environment, society and the performance of business.  The term itself stands for environmental, social and governance and implies environmental issues including climate change and resource scarcity. With sustainability continuing to be a pressing concern for governments and businesses worldwide, the landscape for ESG is growing rapidly and evolving.

At Linear, we are increasingly incorporating ESG investments into our projects, portfolios and products. However, navigating this landscape is highly subjective and at present, there are no widely accepted global standards that define ‘materiality’ for ESG impacts. Due to this, establishing an ESG rating relies on the credibility of a fund manager’s process and whether it is robust, consistently applied and repeatable.

Whilst determining the credibility of an investment in terms of ESG criteria, it is important to scratch below the surface of the terms ‘environmental, social and governance’ and explore the broad range of elements this can cover. For instance, governance can address matters such as board diversity, business ethics and executive pay and social issues can include a company’s talent management, data security, labour practices and product safety. However, whilst these are all important issues, how does this relate to a fund management level and how do fund managers implement this when creating a portfolio.

At Linear, we have established a Environmental, Social and Governance (ESG) rating system for buy-rated investment strategies. This is designed to help investment managers to assess whether and how they should integrate Responsible Investment (RI), and more specifically ESG considerations, into their investment decision making process. We have created these ESG ratings to add a new dimension to our fund analysis, yet they can also sit alongside our existing strategy and operational due diligence processes.

These ratings for ESG criteria are based on a selection of qualitative factors. We begin our processes with a due diligence questionnaire which is carried out by one of our fund managers. At the same time, we conduct a review of a manager’s RI-related policies and procedures. This is inclusive of a review of their RI policy (if they have one), active ownership, proxy voting and/or stewardship policies and examples of real-time application of these policies.

Once we have fully reviewed all data, materials and policies available to us, we take this assessment and measure it against the quality of the conversations with a fund manager concerning ESG criteria. At the same time, we measure these ratings against the degree to which ESG risk factors are incorporated in a manager’s investment decision making processes. Additional factors we consider when establishing an ESG rating include the level of active share ownership a manager can demonstrate alongside active proxy voting policies and the extent of external collaboration a manager undertakes with the wider RI community, furthering best practice and understanding.

Based on all this information, a Lead Analyst at Linear will then determine an ESG rating. These ratings will constantly be updated subject to any changes to a fund strategy or the level of ESG integration and developments across the broader RI landscape. By having an ESG rating system in place, Linear is in a position to best serve our clients and provide advice regarding ESG investments and how to incorporate them into a portfolio.