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ESG integration: at the heart of Smarter Beta

Recent years have seen rapid growth in the consideration of environmental, social and governance (ESG) issues in investment analysis. Socially responsible investing, which screens out investments based on certain criteria, has been employed for decades but investors are increasingly moving to a more nuanced  approach of integrating ESG considerations into investment analysis.

Aberdeen has a long history of embedding ESG considerations throughout our investment processes across equities, fixed income, real estate, alternatives and quantitative investments. We have been a signatory to the Principles of Responsible Investment, the world's leading proponent of responsible investment, since 2007. We believe ESG integration aids competitive financial returns while also providing a comprehensive assessment of the opportunities and risks and of our investments. Through this approach, we also aim to have a positive societal and environmental impact.

As a responsible investor, our Smarter BetaTM equity offering integrates ESG into our investment process at both the universe construction and portfolio construction phases. The rationale is two-fold. Structurally, ESG score levels reflect the intangible benefits of better corporate sustainability and governance. And from a behavioural perspective, ESG performance influences the fundamental value of a company in a way that analysts and financial markets are often slow to recognise.

Our SMARTER Beta™ investment process begins with the construction of the available universe of stocks. For all our indices and funds, we exclude companies facing severe ESG controversies. These include companies involved in the production of controversial weapons, such as anti-personnel mines and cluster munitions.

We also utilise ESG ratings produced by Sustainalytics, a global leader in ESG research, ratings, and analysis. Sustainalytics assigns companies that it covers into five ‘controversy’ levels. Companies deemed to be in Category 5 are considered ‘severe’ – they are the ‘worst of the worst’ in the peer group or sector relating to business ethics, governance, operations, product and impact on  key internal and external stakeholders. Two examples of companies assigned to this category are Volkswagen, which was involved in the 2015 emissions scandal, and BP, as a result of the 2010 Deepwater Horizon oil spill. We systematically remove all Category 5 companies from our investment universe. This leads to stronger risk-adjusted returns than a universe which includes such stocks.

For our bespoke ESG smart beta indices, we implement the above screens but also go one step further by actively targeting companies that score highly on ESG metrics. We integrate ESG analysis through our ongoing engagement with invested companies and through our voting decisions as shareholders.