What is the ESG Vector Score and what does it encompass?
The Northern Trust trademarked ESG Vector Score is a measurement that assesses publicly traded companies in the context of business relevant and financially material ESG related criteria that could impact the operating performance of a company – and its security valuation.
We named it ‘Vector Score’ because it captures both the magnitude of ESG issues and the direction. Specifically looking at whether or not the risks we identify are being well managed against forward-looking risks. Our Score incorporates the two industry-leading sustainability disclosure frameworks – SASB Standards, which are a set of 77 industry-specific, financial materiality standards, and the thematic structure of the TCFD recommendations.
The Northern Trust ESG Vector Score is an industry-first approach marrying these two frameworks to provide a much clearer understanding of industry relevant ESG information. Ultimately, it enables a more intentional and transparent integration of ESG considerations into the investment process, addressing the need for a consistent way to measure and report on ESG investments and inform stewardship practices.
“The ESG Vector Score was intentionally designed as open-architecture, allowing for the flexibility of incorporating additional best-in-class data as it becomes available.“
What differentiates the Northern Trust ESG Vector Score from existing methodologies?
Several things set our Score apart from other methodologies. First and foremost is Northern Trust Asset Management’s 30+ years in the sustainable investing space. Our ESG Vector Score was built on more than three decades of insights and expertise gained by constructing sustainable investment solutions for many of the world’s most sophisticated and progressive investors.
Another differentiating factor of the Vector Score is its multi-dimensional framework, which considers not only how a company is performing relative to its peers, but also looks at how that company may perform in the future. We accomplish this goal through the unique blending of established industry frameworks, taking the SASB’s standards a step further by laying in TCFD recommendations. More specifically, we apply TCFD’s anticipatory framework on governance, strategy and risk management – beyond simply climate – to all financially material ESG risks across the SASB Standards. This informs 80% of our Score. We then place an additional emphasis on corporate governance to recognize the impact it can have on long-term value. The result is a multi-dimensional analysis with a comprehensive and holistic risk assessment of ESG issues across the board.
Recognising that ESG data and reporting continues to evolve, the ESG Vector Score was intentionally designed as open-architecture, allowing for the flexibility of incorporating additional best-in-class data as it becomes available. Thus establishing the Northern Trust ESG Vector Score as a foundational metric that endures over time.
How is the Score used?
Ultimately, the Vector Score is a tool we employ to arrive at a decision-useful metric that fits within our investment framework. We use it in our analysis in vetting a thoughtful approach to analysing ESG issues as they show up in a range of strategies. We have already embedded the methodology in the product design of ETFs that were recently launched in EMEA. Over time, we will be launching a suite of products across geographies that will have the ESG Vector Score in it.
As an investment manager, this tool is also invaluable for our stewardship and engagement efforts. It is a consistent metric that we can use to prioritise engagement, track progress of those engagements over time and serve as a feedback loop between our stewardship and engagement activities back through and into our investment processes and portfolio construction.
“Industry specificity is crucial when analysing companies through a sustainability lens, as the ESG-related business issues that are most likely to impact a company’s bottom line differ from industry to industry.”
Does the Score account for differing ESG issues between industries?
Absolutely, this is a key component of the Score. Industry specificity is crucial when analysing companies through a sustainability lens, as the ESG-related business issues that are most likely to impact a company’s bottom line differ from industry to industry. Take the industries underlying the Food & Beverage sector for example. Consider the different ESG issues that would be focused on between Meat, Poultry & Dairy companies compared to Food Retailers & Distributors. While there is some overlap, given they are both part of the Food & Beverage sector, their distinct business models and operational structures necessitate a focus on separate issues – not dissimilar to how a fundamental research analyst would need to adjust the focus of their analysis when dealing with companies in varying sub-industries.
This is where SASB’s set of industry-specific, financial materiality standards comes in. We underwent a significant due diligence process to select the underlying ESG metrics that would be used to measure and score SASB’s General Issue Categories specific to each of the 77 industries. Each metric was identified as either a ‘primary indicator’ or ‘secondary indicator’ based on the potential impact they might have on a given company within that specific industry.
From an investing perspective, we believe this additional clarity and delineation around key issues is a necessary first step to make informed investment decisions when analysing companies across the spectrum of these identified industries.
“The portfolio construction aspects are obviously important, but the advantages and clarity the Vector Score brings to our stewardship efforts will be of equal importance.”
How can the evaluation of material risks be incorporated into the investment process?
Within the portfolio construction process, there are multiple avenues in which we can deploy the Vector Score across corporate equity and fixed income strategies. Within our quant active portfolios, we are able to integrate alongside compensated risk without diluting the factor exposures, as well as incorporate alongside exclusions and climate targets. Additionally, we can employ the Vector Score in a best-in-class framework for a more rules-based portfolio construction approach for asset owners with tighter risk budgets.
The portfolio construction aspects are obviously important, but the advantages and clarity the Vector Score brings to our stewardship efforts will be of equal importance. The Vector Score will allow the team to identify leaders and laggards across industries and the material SASB General Issues Categories. These insights can be brought into engagements for more pointed discussions with management teams as well as allow us to track company performance throughout the engagement. One of the main goals is to integrate a consistent metric and view of companies throughout the investment lifecycle for use by research teams, portfolio construction, and stewardship.
To dive deeper into how the Northern Trust ESG Vector Score works, download the detailed brief here.
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