Beyond ESG: investment risk through a lens

Impax's latest white paper explores risk management, beyond ESG.

The analysis and management of investment risk dates back to the 14th century in Italy, while the City of London housed the development of the first insurance market in the late 17th century. Ever since, corporate managers and financiers have grappled with their risk exposures and access to capital.

However, the process has frequently failed to prevent large-scale asset value destruction for individuals, institutions and society, as illustrated by the Global Financial Crisis ('GFC') of 2008. In our view, reviews of investment risk suffer from analysis that can be unstructured, short-term, or narrow. Key issues are overlooked as a result.

Since the GFC, those responsible for the management of wealth have rightly been under pressure to identify, assess and mitigate the risks they take when deploying capital. Although new thinking on risk has emerged from many different quarters, the absence of a structured framework and the tendency of analysts to take short-term, narrow approaches to risk assessment have left investors ill-prepared to weather future market turbulence.

Drawing on our investment management experience over two decades, we believe Environmental, Social and Governance ('ESG') research can improve levels of scrutiny. However, we also believe that, on its own, ESG analysis is not enough to address shortcomings in the system, because it suffers from having no consensus in its definition, an incomplete structure, and confusion regarding its application.

The Impax Risk Lens
To achieve a more comprehensive solution, we have developed the Impax Risk Lens, which maps the operating environment in which a company seeks to develop its business over the long term (see illustration below).

The Impax Risk Lens reflects our approach to thinking systematically about the risks facing a company, helping us categorise them quickly, and readily prompting us to investigate other areas that we may have overlooked.

From another vantage point, the Impax Risk Lens facilitates the integration of ESG risk analysis into a holistic process.

With risks facing a company directly mapped at the centre of the Lens, those related to its immediate stakeholders (being suppliers and customers) fall into the first concentric ring, while broader factors in the wider business landscape are captured in the outer ring. For each part of the Lens, individual risk factors can be itemised by more detailed check-lists (with further structure as appropriate).

Breaking down silos
A comprehensive framework for risk analysis should facilitate conversations between those who assess risk from different perspectives. For example, investment analysts who choose to focus on company fundamentals will recognise their concerns in the Risk Lens framework, but be prompted to look more widely for risk factors; the same goes for those who see companies more as stocks whose prices respond to global factors.

The Risk Lens encompasses the topics that an ESG analyst would typically cover, while demonstrating that issues identified by ESG thinking do not necessarily require values-based judgements, and can be useful in quantitative analysis.

Using the Risk Lens
The Impax Risk Lens is designed to help provide context and structure for the process of risk analysis and management. We have found it particularly helpful in understanding the pitfalls faced by companies seeking to achieve a sustainable approach. We believe the Lens provides investors with a straightforward, actionable framework for analysing business risks and associated ESG risks alongside each other.

In Impax's experience, portfolios that account for the risk of both sudden shocks and gradual value erosion tend to outperform, especially over longer time frames. The Impax Risk Lens can assist with the evaluation of both.

To receive the full white paper please email your usual Impax contact.