Engine No. 1 Total Value Framework

INTRODUCTION
September 2021
A New Way
Of Seeing Value
INTRODUCING THE ENGINE NO. 1
TOTAL VALUE FRAMEWORK
1
INTRODUCTION
Table
of Contents
INTRODUCTION 4
Part I:
FROM VALUES TO VALUE 8
Part II:
THE DATA DILEMMA 16
Part III:
THE ENGINE NO. 1 TOTAL VALUE FRAMEWORK 25
2
INTRODUCTION
About Us
Engine No. 1
Engine No. 1 is an investment firm that drives performance through
impact. The firm was founded on the shared belief that a company’s
ability to create long-term shareholder value depends on the
investments it makes in its employees, customers, communities, and
the environment. Learn more at www.engine1.com.
Witold J. Henisz
Witold J. Henisz is the Deloitte & Touche Professor of Management
at The Wharton School, The University of Pennsylvania. He is
also Director of the Wharton Political Risk Lab and the founder
of the Wharton ESG Analytics Lab. His research examines the
impact of political hazards as well as environmental, social, and
governance factors more broadly on the strategy and valuation of
global corporations.
3
INTRODUCTION
Introduction
The last decade has seen exponential growth an approach to responsible investing that
of money flows into investment funds that is still focused on moral purity rather than
claim to incorporate environmental, social, on impact. Early responsible-investing
and governance (ESG) criteria into their pioneers were focused on moral values—not
strategies. Some reports suggest managers financial value—as many of those pioneers
of $40 trillion in assets are now governed were religious investors who for centuries
by mandates that take ESG factors into identified “sin stocks” and removed them
account. The United Nations Principles from their portfolios. Much of the ESG
for Responsible Investment has garnered investing world is still influenced by that
signatories with nearly triple that amount. mode of thinking.
For all the hype and hope in these extrava- Despite vastly improved and more
gant numbers, however, the results have so sophisticated data sources, many of the
far been disappointing. ESG-investing strategies that have emerged
in the last few years are derivatives of this
The financial returns delivered by most ESG
approach.
strategies have been equivocal at best. And
they have produced only a modest impact Accordingly, investors have struggled to
on ESG outcomes: for instance, reductions integrate ESG into mainstream financial
in carbon emissions, pollution, or natural- analysis or thereby afford it the prominence it
resource consumption, or a better customer deserves. A separate but equally formidable
experience and improved employee welfare. challenge has arrived with the entry and
subsequent growth of low-fee passive
Far from changing corporate behavior and
ESG-investment options—itself a response
creating a better world, some ESG funds
both to these data challenges and to the
have served the narrower and more self-
success of low-fee-based passive investing
indulgent purpose of making investors
elsewhere. Absent active managers who are
feel better by excluding obviously “bad”
able to produce superior returns, investors
companies from their portfolios.
have focused their attention on funds that
This failure to achieve goals commensurate mirror indexes modified by the exclusion of
with the ambition is, in part, the legacy of stocks with unfavorable ESG ratings and, in
4
INTRODUCTION
some cases, by the overweighting of more traditional analysis. Such a revolution must
highly rated counterparts. Without more be objective, replicable, and auditable—
convincing evidence of a link between ESG and, as a result, readily incorporated in
and financial performance, such screening financial disclosures, prospectuses, and
or exclusionary strategies will continue to pedagogy.
dominate.
Without such a change, ESG investing is
What’s needed now is a radical new
unlikely to harness the power of capital
research-based approach that integrates
needed to address systemic challenges like
non-traditional but financially material
climate risk and human rights.
ESG data, methods, and systems into
This paper will explore:
01
Part I:
The history of ESG investing, in order to explain the current ESG focus on
purity over impact.
02
Part II:
The flaws inherent in today’s ESG data and measurement, which have kept
ESG analysis mostly disconnected from other financial or operational
analysis of a given company.
03
Part III:
Engine No. 1’s new framework, which we believe addresses these flaws and
gives us a new vision of value as investors.
5
INTRODUCTION
We developed our Total Value Framework net income, market capitalization, and
to address the current deficiencies in ESG earnings multiples. The association between
data and to help investors generate lasting stakeholder value and these financial
impact on corporate behavior and robust outcomes has indeed turned out to be far
long-term financial returns—not just the stronger and more robust than have the
warm glow of a “pure” portfolio. observed correlations between traditional
ESG metrics and these same outcomes.
Through the Total Value Framework, we
attempt to measure the value companies Crucially, the framework’s analysis informs
create or destroy for both shareholders and our decisions as investors—the investments
stakeholders— their employees, customers, we make, as well as what we subsequently
communities, and environment—as well do as owners. We believe investors can
as on the connection between the two only effect lasting change when they work
groups. Instead of ESG scores and ranks, as active owners. With the Total Value
which in effect constitute little more than Framework, we come armed with an
emojis and are as difficult to incorporate into approach that is rooted in data, connected to
spreadsheets or algorithms, we try where value, integrated with our investing process,
possible to quantify the impact in dollars. and focused on change.
We use independent sources and estimates
to assess the firm-level costs of emissions, The uncomfortable truth for large swaths of
resource use, waste, social practices, and a the ESG “industry” is that current approaches
host of other ESG factors. to measuring ESG performance in scores or

ranks look good in ESG reports, but they are
Armed with this new data, we can proceed to extremely difficult to incorporate into the
focus on how the value a company delivers analyses that investors and companies use
to its stakeholders affects the value it is then to actually make decisions.
able to impart to its shareholders. This
forces us to examine drivers like potential Without more convincing evidence of a link
regulation, changes in customer or employee between ESG and performance, screening
preferences, technological disruption, and or exclusionary strategies will continue to
other relevant contributors to a company’s dominate. We need new thinking and honest
risk or growth. appraisal. Without it, we face the danger

that the passion, energy, and vision that
For example, we can show that variations have gone into the ESG movement will soon
in the level of value a company creates or dissipate into a cloud of uncertainty and
destroys for its stakeholders strongly predict confusion. With the Total Value Framework,
future shifts in financial value, including we’re offering a new way of seeing value.
in revenues, worker productivity, earnings,
6
INTRODUCTION
01
FROM VALUES TO VALUE
A Short History of ESG Investing
7
ESG emerged into today’s investing mainstream from old roots.

The earliest responsible investors began as a fringe prohibitionist
protest against “socially unacceptable” activities. Responsible
investors have since developed a range of tactics, but many are
derived from this initial desire for moral purity. We can see this
history most clearly in three of the most common ESG strategies
today: exclusionary screens; portfolio optimization and tilting; and
as a factor within broader smart-beta strategies. In all of these
cases, investors use ESG characteristics to decide whether to
include a given company in their portfolios.
Exclusionary screens the South African apartheid and the

Vietnam War, financial institutions offered
Early initiatives to encourage socially portfolios that omitted not just companies
responsible investing targeted “offending” in the traditional “sin” sectors but also those
products like guns, tobacco, pornography, operating in South Africa or contracting with
or bad practices such as environmental the US defense department. The Pax World
degradation and human-rights abuses. Fund (1971), The First Spectrum Fund (1971)
Investors would simply avoid buying such and The Dreyfus Third Century Fund (1972)
companies’ stocks.
were early entrants.i
Many of these investors took their cue
Investors in these funds were motivated
from religious orders such as Quakers,
more by ethical principles than by the
Methodists, and Muslims, many of whom
prospect of improving their risk-adjusted
had long prohibited investment in businesses
returnii—and perhaps just as well, since
associated with slavery, weapons, or alcohol.
researchers have found that exclusionary
An early example was the Pioneer Group, a
strategies either mirror market returnsiii or
mutual fund founded in 1928 that excluded
slightly underperform them.iv There may
companies involved in tobacco, alcohol, and
have been some financial benefits in the
gambling.
form of lower risk,v particularly during crises,
In the wake of the 1970s campaigns against although such outcomes were unintended.vi
8
These investors’ impact on corporate However not all studies corroborate

behavior was also limited. And in fact a evidence of a strong link, in part due to the
growing body of theoretical and empirical inconsistency of the data.xi
research has challenged the idea that
The appetite for portfolio optimization and
excluding companies from a portfolio, or
tilt strategies is undeniably strong, but the
divesting, is effective as a lever for impact.vii
evidence is still piecemeal.
Researchers have found that only a handful
of “offending” companies and industries
changed their practices in response to the ESG as a factor in smart-beta
actions of these early funds.
strategies
Rather than re-weighting a portfolio based
Portfolio optimization and tilting on companies’ ESG performance, investors
More recently, ESG investors have gone can also integrate ESG factors into portfolios
beyond the binary choice of including or constructed around other traditional factors
excluding companies. Instead, they will as well—like value, momentum, size,
shift the weights of companies within volatility, and quality.
their portfolios to reflect some view of
Based on recent analyses, companies with the
ESG performance—perhaps doubling or
most positive ESG ratings tend to show only
tripling the weight of companies with high
moderate overlap with existing strategies,
ESG ratings while removing or reducing the
weight of low-rated names. That stands emphasizing ESG’s effectiveness as a
in contrast with an exclusionary investor, standalone factor in investment portfolios.

who may prefer to invest in a market-cap- Moreover, since more highly ESG-rated
weighted S&P 500 index fund that excludes companies tend to exhibit lower volatility, an
(for instance) oil and gas stocks. ESG factor can lead to better risk-adjusted
returns in the form of a higher Sharpe ratio.
The former practice is often known as
Leaders in the development of the smart-
“portfolio optimization” or “tilting.” And
beta ESG factor include RobecoSAM, with
its goal—unlike that of some exclusionary
their Sustainability Investment Factor,xii
strategies—may be increasing an investor’s
and MSCI.xiii These firms are supported
financial risk-adjusted return.
by a growing body of research—including,
Naturally, researchers have tried to identify in particular, studies of credit riskxiv—that
formulas that generate above-average corroborate the potential risk reduction of
returns by tilting toward these higher- those efforts.xv Some studies, however, still
performing ESG firms, those on an upward
viii
dispute the existence of an ESG factor,xvi
improvement trajectory in relation to ESG, ix
once again highlighting the need for more
or those attracting strong ESG sentiment. x
consistent and transparent data disclosure.
9
The rise of low-fee, passive ESG a surge of ESG ETF offerings with fees at
or below those of benchmark funds. The
investing downward pressure on fees is diluting the
With high-fee, active managers still distinctiveness of ESG funds in comparison
struggling to prove they can generate alpha with their benchmark peers as less distinctive
by integrating ESG into their investing low-fee funds have dominated growth.
processes, investors have turned their focus
When it comes to financial performance,
to cost and convenience. The largest-growth
moderate-, high-, and low-fee funds have
segment in the ESG space has comprised
been roughly comparable: each group has
low-fee funds that largely mirror passive
underperformed its respective benchmark
indexes, but with the application of exclusion
by a fraction of a basis point. But ESG
or portfolio optimization and tilting strategies.
performance among the low-fee funds
Recent trends are clear. Fees for ESG mutual differs more substantively versus peers,
funds have fallen from 1.3% in 2007 to under actually coming in under the relevant
1.2% in 2020, and since 2016 there has been benchmarks.
Figure 1: Low-fee ESG funds gain share (of assets under management) in 2018-2020
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
High Medium Low
10
The upshot is that while investor interest ESG characteristics into their investment
in ESG funds is surging, money is flowing decisions if they are committed to the belief
into funds that, by some metrics, have the that a company’s impact on society and
lowest ESG performance within the category the environment affects that firm’s ability
and may even underperform their ESG to generate long-term value. Only then
benchmarks. Many are run by established will ESG move from its current status as
incumbent asset managers with scant temporary fad to a permanent position in
track records in ESG investing. In fact, in best-in-class investing.
some cases these managers simply rebrand
But, not surprisingly, skepticism is widespread.
existing funds with an ESG label after
Annual surveys by the Callen Group over
introducing relatively superficial changes in
the last five years suggest that the majority
exclusions or investment strategy. xvii Claims
of institutional investors do not consider
of ESG greenwashing appear justified.
ESG factors to be material to financial
The rise of low-cost ESG options, performance. The minority of respondents
counterintuitively, raises the bar for those who have incorporated ESG factors into
trying to integrate ESG factors into their their investment decisions cite a mix of
investing decisions in core and fundamental stakeholder pressures, values- or impact-
ways. Specialist asset managers pursuing based arguments, potential correlations with
“active” ESG strategies and seeking to fuse risk, and financial returns. Significantly, the
traditional financial and new ESG analysis prospect of “higher long-term returns” is one
now have to compete for new business not of the weakest incentives.
only with early ESG entrants, but also with
Two trends in ESG investing may illuminate
mainstream incumbents offering the lure of
the way forward. The first is fully integrating
cheaper alternatives. New ESG investors will
ESG factors into the fundamental financial
need a clear, compelling, and convincing
and operational analyses that investors
evidence-based proposition if they are to
already rely on. The second is working as
overcome inbuilt loyalty to incumbent fund
an active owner: engaging directly with
managers.
companies to improve and, in doing so,
increasing their value. Both of these promise
The path forward for ESG to take ESG investing well beyond its current
trajectory.
investment
The challenge for investors lies in the
temptation to pander to stakeholder pressure
ESG integration
just by purchasing a new ESG data set or Rather than allowing a company’s ESG
by hiring some token specialists. Investors performance to inform its weight in a
must find ways to fully integrate a company’s portfolio, true integration of ESG into
11
fundamental analysis requires a bottom- training is not only time-consuming but is

up process in which environmental, social, also likely to encounter industry resistance
and governance issues are integrated into given the immediate costs of investments in
financial-model forecasts. This means ESG human capital, data, and modeling versus
data would not be held as a distinct factor, the further-out benefit of higher returns,
but would instead be used in assessing such which may not emerge for three to five
line items as revenue, operating margins, and years.xx And the dominance of passive, low-
risk that ultimately drive the numerator of cost investment strategies stands to amplify
the reluctance to accept this J curve. Not
intrinsic valuation and the expected return.
surprisingly, this same challenge also exists
ESG factors are financially material because
within companies seeking to invest in better
they can affect top-line growth, costs and
ESG practices.
margins, regulatory and legal interventions,
employee productivity, and investment and For ESG investors, the Holy Grail is
asset optimization. xviii successfully integrating reliable ESG data
into broader financial analysis. At the
Investors have recently indicated a moment a company’s weight in an ESG-
preference for scenario-based analyses orientated portfolio is typically determined
as the best way to quantify ESG-related by ratings that are often inconsistent and
issues, xix especially following calls by uncorrelated, and which therefore provide
regulatory bodies like the Financial Stability a crude ranking that may have the zip of
Board’s (FSB) Task Force on Climate-related emojis but about as much rigor as well.
Financial Disclosures (TCFD) for companies What’s lacking is a bottom-up process
to report their own climate change scenarios. that reflects the impact of ESG issues on a
company’s value.
An important challenge for the future will
The industry needs to build those new
be training analysts to integrate ESG factors,
capabilities, even amid the current
including regulatory risk, gender diversity,
challenging environment.
energy efficiency, and human rights, into
their core business assessments. Analysts
may know the businesses they cover inside
Active ownership and corporate
and out, but they do not necessarily have engagement
the expertise on climate, human rights, or All of the strategies above—both historical
other ESG issues that would be required in and current—have focused on using ESG
order for them to ask companies the right to make investing decisions. But none
questions, to adjust their fundamental address how investors can use ESG factors to
models, or to make recommendations determine their engagement with companies
based on an integrated assessment of the once those shares are purchased. Here,
traditional and non-traditional factors again, we’re seeing a possible new direction
that will influence long-term returns. Such for the ESG movement.
12
Pension funds in Europe and the US have releases, greenhouse gas emissions, and
long engaged on ESG (and particularly on cancer-causing pollution due to the firms’
governance issues), among them CalPERS, investments in abatement technology.
NBIM, and APG. Endowed with “partnership”
Coordination by activists appears to be a
mindsets, long-term investment horizons
determinant of successful engagements.xxii
and sizeable ownership stakes, at times these
One study examined thirty-one campaigns
players have had a significant impact on
on the Principle for Responsible Investing
corporate strategy and behavior—as well
as on financial performance. platform, and it found that coalitions with
a lead investor from the same country as
From 1987 to 2010, for example, CalPERS that of the targeted company, and a wide
targeted a small number of companies array of capable and influential supporters,
it deemed to be underperforming on are more likely to drive change and boost
governance—notably in board quality and performance.xxiii Similar results are reported
diversity, reporting transparency, investor in a study of 256 engagements conducted
rights, management of environmental and by the Canadian Coalition for Good
social issues, and shareholder alignment Governance.xxiv
on executive compensation. The agency
highlighted those companies in a name- So engagement appears to be a more
and-shame campaign called the Focus List. effective way to achieve change than
Then, after 2010, it shifted to a more private are exclusionary screens, although it is
engagement strategy. nevertheless more costly and allows other
stakeholders a “free ride.” In this context,
The impact has been significant. In 2014 the recent concentration of the asset-
Wilshire Associates, a consultant to the management industry may be beneficial.
CalPERS board, published an analysis of
Some argue, however, that index-based
the 188 companies in the Focus List program
investing (which allows for a swift exit)
for the period between 1999 and fall 2013.
limits the scope of big funds in their ability to
These outperformed their Russell 1000 sector
make a significant impact, and that the same
benchmarks by 11.9%.xxi
applies to the conflict of interests inherent
Other studies have likewise found evidence in these firms’ management of corporate
that engagement can both yield higher pension funds. Whatever the reasons, the
financial returns and prompt companies current pace and scope of engagement
to take remedial action. One looked at plants activity is certainly insufficient for achieving
targeted by the New York City Pension such systemic change as that sought by the
System’s Boardroom Accountability Project, net-zero emissions target or the Sustainable
and it found substantial reductions in toxic Development Goals of the United Nations.
13
Conclusion: company’s sector, ratings, or scores. But the

more pragmatic “impact” question is being
From values to value asked by an increasing number of investors.
Through its history, ESG investing has meant To answer this, they must understand how
many things to many people. For the earliest their investing decisions affect a company’s
responsible investors, it was a way to purge operations and externalities, and how those
“sin stocks” from their portfolios. But for operations and externalities then influence
some recent investors the question has that company’s performance.
changed from “How pure is my portfolio?”
To do this, they must eschew the simplifying
to a new question: “What impact do my
“purity” approaches of exclusion or portfolio
investments have?”
optimization and tilting, and instead focus
When investors begin with the “pure” on the hard “impact” work of true ESG
question, it makes sense to look at each integration and active ownership.
14
INTRODUCTION
02
THE DATA DILEMMA
The Flaws in ESG Metrics, Ratings, and Analysis
15
THE DATA DILEMMA
Without objective, consistently available data on ESG performance

it’s difficult to constructively pursue any of the ESG-investing
strategies we’ve described. While some norms have evolved,
there is still no regulatory guidance regarding what to disclose and
in what form. Indeed, questions pertaining to data integrity and
reliability act as significant constraints on researchers in the field.
The environmental and social activists who correlations and data analysis rather than
developed ESG data-reporting standards any overarching theory or framework.
were concerned about quantities of output
by firms or incidents, and this focus persists Again, these analysts and modelers are
in the vast majority of current reporting by the left with the ESG equivalent of emojis—
companies and third-party rating agencies extremely difficult to integrate into the
that process this data into rankings or scores. analysis of a company’s growth rates,
Increasingly, however, the audience for this profits, or potential losses. We need to bring
data—ESG data consumers—are financial new data to the discussion and follow this by
analysts seeking to integrate ESG information asking different, more substantive questions.
into their investment strategies. This presents a

significant challenge, as many analysts are not The state of ESG data today
well versed in the technical and engineering
components of environmental mitigation. Thanks to much-improved standards of
Therefore, determining actual environmental corporate disclosure, the quantity of ESG
impact is somewhat subjective, even with a data has grown substantially in recent
rating system. years. In 2021, for example, Bloomberg
terminals offered 900 ESG data fields for
These financial analysts and modelers 13,000 companies covering the last twelve
have adapted to the norms of disclosure. years, amounting to 140 million data points
But ultimately they have to integrate ESG (against 6 million in 2015 and just 1.5 million in
performance into a dollar-denominated 2010). By 2016, 81% of S&P 500 components
financial model even as such performance were issuing sustainability reports, and by
is typically measured in various units of 2020 that number had increased to 90%.
output or standardized into scores. They
do this without the scientific knowledge Impressive as this sounds, there are wide
of conversion factors, relying on simple variations in the content and format of these
16
THE DATA DILEMMA
disclosures. By one count, there are now more strategic governance. Its ratings explicitly
than 230 corporate sustainability standard compare a company with industry peers, and
initiatives; another study, meanwhile, found they are designed to help investors achieve
twenty different reporting schemes for supranormal risk-adjusted returns through
employee health and safety data alone. portfolio optimization and tilting and smart-
beta strategies. RobecoSAM was among those
In order to address the growing proliferation
that adopted this same approach.
of metrics and standards, the World
Economic Forum’s International Business As interest in ESG data has developed among
Council (WEF IBC), in cooperation with mainstream financial investors over the last
the Big Four accounting firms (Deloitte, EY, ten years, the primary financial-service data
KPMG, and PwC), has offered a harmonized providers have acquired their own expertise,
set of twenty-one core and thirty-four often through the acquisition of ESG data
expanded metrics for ESG reporting that providers.1 More recently a new breed of
are aligned with the existing framework player has been using web crawlers and
and standard-setting bodies. natural language parsing, often combined
with artificial intelligence, in an attempt to
In addition to competing standards, a host supplement companies’ voluntarily released
of private-sector data providers offer information with relevant media-event data
proprietary ratings, each with its own and other unstructured text.2
adjustments and weighted indexes or scores.
Notwithstanding this flood of third-
Examples include Kinder, Lydenberg, party rankings and increased voluntary
Domini & Co, Sustainalytics, ASSET4, and corporate disclosure, much of the new data
Vigeo Eiris. All of these providers follow is inconsistent and it often omits the most
distinct methodologies for use of voluntary material information—and it is, therefore, of
disclosures as they construct measures of limited financial value to investors. A recent
a company’s social performance relative study characterizes the field of ESG metrics
to some absolute standard of practices, as one of “Aggregate Confusion.”3 We feel that
processes, and outcomes. while this is a start, we need to expand the
reporting metrics and standards to include
Innovest, launched in the late 1990s, has sought more rigorous scientific and engineering
to provide scores as a proxy for the value of principles, grounded in robust and
such intangible assets as the environment, representative data science and analysis.
human capital, stakeholder capital, and
1
KLD and Innovest were taken over by MSCI, which also acquired ISS; Sustainalytics was acquired by Morningstar which also collaborated
with Glass Lewis; ASSET4 was acquired by Thomson Reuters, which also owns 45% of Refinitiv; and Vigeo Eiris was taken over by Moody’s,
and RobecoSAM by ORIX.
2
Examples include TruValue Labs, Arabesque, Ravenpack, RepRisk, government regulatory filings (SenseFolio and SigWatch), NGO
statements and reports (TruValue Labs, Reprisk, Sigwatch).
3
Berg, F., Koelbel, J. F., & Rigobon, R. 2019. Aggregate Confusion: The Divergence of ESG Ratings: MIT Sloan School of Management.
17
THE DATA DILEMMA
These data providers report scores, indexes, worryingly low6 (typically below 0.6 and, in
or counts at varying levels of aggregation and some cases, as low as 0.05, in comparison
at varying intervals. with the 0.9 commonly observed on credit
ratings). 7 These disagreements allow
Company performance scores can differ companies themselves to pick and choose
dramatically, even on the same ESG factor,4 which rating to highlight—decisions that are
with ratings sometimes structurally biased bound to be self-serving and which further
in favor of large firms or those that fulfill undermine investor confidence in certain
regulatory requirements.5 While different stocks. As input data evolves, we propose the
ESG data providers typically agree on development of new scoring metrics which
which firms are the worst-performing, are sector agnostic and climate-specific.
correlations outside the bottom decile are
Figure 2: Low correlations across data providers in ESG ratings
ASSET4
Sustainalytics
Reprisk
TruValue
MSCI ASSET4 Sustainalytics Reprisk
Note: Each graph plots the ESG scores for the provider labeled in the associated row or column. If the measures were perfectly
correlated, the dots would all appear on the 45-degree line.
4
Boffo, R., & Patalano, R. 2020. ESG Investing: Practices, Progress and Challenges: OECD.
5
Doyle, T. M. 2018. Ratings That Don’t Rate: The Subjective World of ESG Rating Agencies: American Council for Capital Formation.
6
LaBella, M. J., Sullivan, L., Russell, J., & Novikov, D. 2019. The Devil Is in the Details: The Divergence in ESG Data and Implications for
Sustainable Investing: QS Investors, Lopez, C., Contreras, O., & Bendix, J. 2020. ESG Ratings: The Road Ahead. Munich Personal RepEc
Archive, 103259.
7
Dorfleitner, G., Halbritter, G., & Nguyen, M. 2015. Measuring the Level of Corporate Responsibility: Journal of Asset Management.
8
Avramov, D., Cheng, S., Lioui, A., & Tarelli, A. 2020. Investment and Asset Pricing with ESG Disagreement. Available at SSRN: https://ssrn.
com/abstract=3711218 or http://dx.doi.org/10.2139/ssrn.3711218.
18
THE DATA DILEMMA
APPLE MICROSOFT
ESG
Environmental
Social
Governance
0 25 50 75 100 0 25 50 75 100
AMAZON FACEBOOK
ESG
Environmental
Social
Governance
0 25 50 75 100 0 25 50 75 100
JP MORGAN BERKSHIRE HATHAWAY
ESG
Environmental
Social
Governance
0 25 50 75 100 0 25 50 75 100
Rating agency 1 Rating agency 2 Rating agency 3 Rating agency 4
Figure 3: Divergence in ESG ratings across large, global companies

Source: MSCI, Sustainalytics, RobecoSAM, and Refinitiv. Ratings as of February 2019. Rating Agency 1 represents MSCI ESG ratings, Rating Agency 2 represents Thomson
Reuters ESG ratings, Rating Agency 3 represents Sustainalytics ESG ratings, Rating Agency 4 represents RobecoSAM ESG ratings. Link here: https://www.leggmason.com/
content/dam/legg-mason/documents/en/insights-and-education/whitepaper/lm-qs-the-devil-is-in-the-details-0919.pdf.
19
THE DATA DILEMMA
Figure 4: Correlation at aggregate ESG level and at E, S, and G levels
SA - VI SA - KL SA - RS SA -A4 VI -KL VI - RS VI -A4 KL -RS KL - A4 RS - A4

ESG 0.73 0.53 0.68 0.67 0.48 0.71 0.71 0.49 0.42 0.64
E 0.70 0.61 0.66 0.65 0.55 0.74 0.66 0.58 0.55 0.70
S 0.61 0.28 0.55 0.58 0.33 0.70 0.68 0.24 0.24 0.66
G 0.55 0.08 0.53 0.51 0.04 0.78 0.77 0.24 -0.01 0.81
Econ - - - - - - - - - 0.43
Correlations between the ratings on the aggregate level (E, S, G, and ESG) from the five different rating agencies are calculated using the common sample. The results are similar
using pairwise common samples based on the full sample. SA, RS, VI, A4, and KL are short for Sustainalytics, RobecoSAM, Vigeo-Eiris, ASSET4, and KLD, respectively.
Figure 5: Correlation between rating agencies at the level of categories (SASB taxonomy)
KL:A4 KL:RS KL:SA KL:VI RS:A4 RS:SA SA:A4 VI:A4 VI:RS VI:SA Average
GHG Emissions -0.12 -0.07 -0.05 0.40 0.44 0.63 0.57 0.71 0.34 0.32
Air Quality 0.42 0.42
Energy Management 0.27 0.31 0.12 0.24 0.22 0.26 0.30 0.45 0.37 0.38 0.29
Water & Wastewater Management 0.23 0.20 0.31 0.32 0.12 0.42 0.40 0.40 0.47 0.47 0.33
Waste & Hazardous Materials
0.27 0.36 0.36 0.33 0.17 0.20 0.40 0.37 0.46 0.38 0.33
Management
Ecological Impacts 0.43 0.42 0.49 0.40 0.70 0.71 0.65 0.59 0.70 0.66 0.57
Human Rights & Community
0.17 0.16 -0.26 0.23 0.64 -0.12 0.06 0.52 0.54 -0.01 0.19
Relations
Customer Privacy 0.32 0.36 0.27 0.32
Access & Affordability 0.45 0.53 0.58 0.48 0.65 0.48 0.53
Product Quality & Safety 0.02 0.19 0.02 0.05 0.37 -0.10 -0.05 0.25 0.49 -0.09 0.11
Customer Welfare -0.02 -0.04 0.23 -0.09 0.46 -0.13 -0.13 0.52 0.50 -0.06 0.12
Selling Practices & Product
0.20 -0.34 -0.47 -0.08 -0.11 0.60 -0.07 0.00 0.43 0.40 0.06
Labeling
Labor Practices 0.16 0.10 0.20 0.26 0.42 0.46 0.40 0.51 0.57 0.56 0.36
Employee Health & Safety 0.28 0.24 0.04 0.30 0.57 -0.15 -0.16 0.71 0.63 -0.14 0.23
Employee Engagement, Diversity

0.15 0.16 0.13 0.18 0.61 0.40 0.55 0.56 0.51 0.58 0.38
& Inclusion
Product Design & Lifecycle
0.36 0.32 0.26 0.13 0.54 0.37 0.52 0.35 0.38 0.46 0.37
Management
Supply Chain Management 0.16 0.11 0.17 0.17 0.56 0.53 0.53 0.63 0.64 0.56 0.41
Materials Sourcing & Efficiency 0.59 0.33 0.34 0.42

Physical Impacts of Climate
0.44 0.45 0.56 0.48
Change
Business Ethics 0.27 0.02 0.05 0.00 -0.18 0.50 -0.13 -0.17 0.57 0.57 0.15
Competitive Behavior 0.55 -0.04 -0.05 0.15

Management Legal & Regulatory
-0.02 0.09 -0.02 0.02
Environment
Critical Incident Risk Management 0.03 -0.21 0.07 -0.04
Systemic Risk Management 0.26 0.26
0.23 0.21 0.13 0.15 0.37 0.30 0.26 0.39 0.53 0.34
Correlations between the different categories from different rating agencies. We calculate a value for each criterion on the firm level by taking the average of the available
indicators for firm f and rater k. As indicators depend on industries the values of the same criterion but for different firms might not use the same indicators as input. The
panel is unbalanced due to differences in scope of different ratings agencies and categories being conditional on industries. The SASB categories of data security and
business model resilience are not displayed in this table, because either none or only one of the rating agencies provides indicators for these categories.
20
THE DATA DILEMMA
Sector-specific materiality determining sector-specific materiality.
The Materiality Map encompasses thirty

One response to this inconsistency has been
generic sustainability issues—everything from
growing support for materiality: the principle
labor relations to GHG emissions, and covering
that what is measured and disclosed should
five sustainability dimensions applicable
be material to investor decision-making,
to most industries11 (environment, social
with the understanding that what is material
capital, human capital, business model and
is likely to drive financial performance. In
innovation, and leadership and governance).
our view, materiality has become an ESG
Three tests determine potential sector-
buzzword—we propose to give it meaning
specific materiality: “evidence of interest,”
through the Total Value Framework.
which utilizes a keyword-based heat map to
The Sustainability Accounting Standards determine which general sustainability issues
Board (SASB) pioneered materiality- are most important to investors and other
based ESG metrics with its trademarked key stakeholders; “financial impact,” which
Materiality Map—an interactive tool that pertains to the likely impact of management
provides a snapshot of sector-specific ESG decisions on future valuations; and “forward-
issues deemed material to a reasonable looking impact,” intended to identify issues
investor, and first inspired by the Harvard not previously captured that could prove
Initiative for Responsible Investment. 8
systemically disruptive in the future.
“Reasonable investor” is defined within the
The resulting interactive Materiality Map then
SASB’s methodology as “an investor who
shows the relative significance to the sector
invests primarily for economic reasons with
of each of these generic sustainability issues.
a variety of investment horizons—from
short-term to long-term—and investment As former SASB CEO Jean Rogers has
strategies—from income generation to asset explained, this empowers companies to “focus
valuation.”9 “Materiality” follows the U.S. their sustainability strategies on the most
Supreme Court definition in US securities important issues” while providing “investors
law as presenting “a substantial likelihood with a ‘heat map’ of portfolio exposure to
that the disclosure of the omitted fact sustainability risks and opportunities.”12
would have been viewed by the reasonable
investor as having significantly altered The Total Value Framework proposes
the total mix of the information made moving the discussion from heat maps to
available.”10 The tool is regularly updated actionable insights around a company’s
via the SASB’s test-based methodology for environmental and financial performance.
9
Lydenberg, S., Rogers, J., & Wood, D. J. 2010. From Transparency to Performance: Industry-Based Sustainability Reporting on Key Issues:
Initiative for Responsible Investment.
10
Sustainability Accounting Standards Board (SASB). 2013. Conceptual Framework of the Sustainability Accounting Standards Board.
11
Mooney, C. 2014. GRI & SASB: An Understanding of Alignment: BrownFlynn.
12
Rogers, J. 2016. Remarks to the SEC Investor Advisory Committee. Prepared remarks.
13
Ibid.
21
THE DATA DILEMMA
The adoption of the concept of materiality—

Corporate ESG reporting
incorporated into existing and new
third-party ratings by the likes of MSCI,13 Some companies, meanwhile, have
RobecoSAM,14 and TruValue Labs15—has also been trying to embrace the idea of
improved the quality of ESG portfolio materiality in their reporting. One approach
optimization (or tilting) and smart- has been to break out what is financially
beta strategies, and has made corporate material in sustainability reports. Others
engagement more effective. have sought to quantify the impact of firm
activity on the natural environment; to
But the new methods still fall short of
calculate the multiplier effect of poverty
true ESG integration, which requires
levels, employment, and tax payments on
a new class of metrics divorced from
the wider economy; to measure the upside
the inconsistent, subjective scores that
of worker benefits, training and other non-
still prevail. Correlations with financial
monetary compensation (in terms of, for
outcomes remain low for these scores, and
example, reduced injuries or improved
the rationales of different data providers are
quality of life); and to catalogue measures of
opaque.
customer welfare, such as willingness to pay.
Without clearer meaning and definitions,
Early adopters include Puma, with its
auditors will continue to struggle to fully
Environmental Profit & Loss Account;
integrate ESG data into financial reports.
Unilever, with assessments of its total
And as long as the interpretation of data is
impact on poverty in Indonesia (this
more art than science, any widespread effort
grew into “brand imprint” assessments
to train analysts on how to appropriately
globally); and Standard Chartered and
model ESG data will remain elusive.
Newmont Gold with their efforts to
14
MSCI provides materiality-based ESG ratings meant to convey the ESG risks and opportunities of specific issuers relative to sector peers,
as defined by Global Industry Classification Standard (GICS) sub-industry levels. To establish materiality, MSCI identifies thirty-seven
key issues within each industry across ten themes within the three categories of environmental, social, and governance. Examples
of key issues include carbon emissions, labor management, and ownership structures. Each key ESG issue is mapped annually using
a quantitative assessment that looks at the range and average values of each industry for externalized impacts, and subsequently
produces a sector-specific weighting. These key issue scores are then weighted within the context of the E, S, and G pillars to arrive
at ratings of AAA-CCC. Melas, D., Nagy, Z., & Kulkarni, P. 2016. Factor Investing and ESG Integration: MSCI.
15
RobecoSAM’s sustainability rating, or smart score, process begins with its annual Corporate Sustainability Assessment designed to
capture industry-specific and financially material sustainability factors under three distinct dimensions: environmental, social, and
economic (including governance). Invited to participate in the annual assessment are the 3,400 largest publicly traded companies
globally based on float-adjusted market capitalization. Each sector has its own questionnaire based on rules-based materiality
derived from years of assessment responses and the expertise of RobecoSAM’s internal sustainability analysts. Questions include
the extent to which firms disclose material ESG risks, undertake sensitivity analysis on ESG factors, monitor key performance
indicators covering these factors, and incent their managers according to performance on these metrics. Additional detailed
questions cover such topics as climate risk, supply chain risks, diversity, water risks, and community risks. The full questionnaire
extends beyond one hundred pages for some firms. To construct a rating, each question and dimension is assigned a weighting
based on the materiality assessment and ultimately aggregated into a sustainability score of 0-100. To eliminate bias in determining
materiality and subsequent weights, RobecoSAM balances the number of criteria chosen for each dimension and, drawing on its
historical database, establishes criteria significance through multi-variate regression. The result is a score that can be used to inform
active investors in their fundamental analyses and as an input for RobecoSAM’s own Sustainability Investment Factor.
16
TruValue Labs takes a slightly different approach than the two aforementioned providers. Through a unique combination of artificial
intelligence, machine learning, and sector-specific materiality, as defined by the SASB, TruValue provides score-based ratings
in real time to end users through its Insight360 platform. In a three-step process that begins with aggregating data from 75,000-
plus sources, Insight360 extracts sustainability content and categorizes it into fourteen categories (some of which can be user-
customized). The data is then normalized within each SASB category and weighted by timeliness, frequency, and intensity to provide
end users with a dynamic scorecard of real-time ESG updates. A multitude of ESG categories, in addition to an overall category, are
scored on a scale of 0 to 100, with scores above 50 indicating positive ESG-related sentiment, and those below 50 indicating negative
sentiment. These scores are available in a long-term trend score, a momentum score that shows the direction in sentiment, and a
short-term “Pulse” score.
22
THE DATA DILEMMA
assess the total contributions of their metrics are unstandardized, ratings are
upstream and downstream operations uncorrelated, and analysis is disconnected
to the Ghanaian economy. Moreover, from the other financial and operational
PwC’s Total Impact Measurement and analysis conducted by investors.
Management (TIMM), EY’s Total Value
But as investors begin to move from the
Framework, Deloitte’s Social Impact
aforementioned “pure portfolio” question to
Measurement Model (SIMM), and KPMG’s
that of actual impact, we believe they will
“New Vision of Value” have synthesized and
approach ESG in new ways.
standardized methodologies for estimating
the impact of corporate actions on the • Analysis is integrated: The connection
natural environment, economies, workers, between investors’ actions, their social
and consumers. In academia the Return and environmental impact, and the
on Sustainability Investment (ROSI) companies’ financial performance
framework and toolkits—developed by becomes the most important question,
Tensie Whelan at the Center of Sustainable rather than a merely incidental one.
Business at New York University’s Stern • Metrics and ratings focus on change:
School of Business—provide off-the-shelf Rather than attempting to gauge which
spreadsheets and guides for identifying companies are “good” or “bad,” investors
and measuring the mechanisms by which consider how their investment in a
sustainability investments can improve company may improve it and heighten
financial performance. The Impact the value it delivers to society. If equipped
Weighted Accounts Initiative, led by George with this mindset, then standardized, well-
Serafeim at Harvard Business School, uses correlated ratings and scores become
voluntarily reported corporate data for the more useful as measures of improvement
assessment of thousands of companies. rather than remaining fixed, point-in-
time assessments.
Each firm is, however, allowed to choose
the measures and methodologies it wishes • Investors become active owners: Rather
to report. So the temptation, particularly for than excluding companies from their
recent corporate adopters, is to make one’s portfolios or underweighting them,
self look better in the eyes of stakeholders investors focus on how their votes, or
without changing underlying practices. the work they do with companies, can
Standardization of all these frameworks is be a critical lever in creating long-term
therefore a vital next step. value for shareholders and stakeholders.
Already among those showing the way
here are pension funds rooted in the labor
Conclusion: Moving toward a movement, with a culture that is unafraid
new approach of exercising power to create change.
The financial world has been flooded with All of this requires investors to approach ESG
new ESG data in recent years, with no end in as a new way of seeing value—something
sight. But despite the growing amount of ESG that we believe our Total Value Framework
data and the sophisticated nature thereof, can help accomplish.
there are still three principal challenges:
23
INTRODUCTION
03
THE ENGINE NO. 1
TOTAL VALUE FRAMEWORK
Building a Better Way
24
THE ENGINE NO. 1 TOTAL VALUE FRAMEWORK
Up until now the thrust of most ESG strategies has been to find the
answer to a simple question: are the companies we’re investing in
good, or are they bad? By doing this we could exclude sinners—or
at least reduce their weight in our portfolios—and enjoy a warm
glow of moral satisfaction. But what we couldn’t do was link our
values about right and wrong to the source of long-term financial
value and profitable investing.
That’s why we believe that Engine No. 1’s new Total Value
Framework is such an important step forward. It’s a data-driven
approach to investing that puts tangible value on a company’s
environmental, social and governance impacts and then ties those
impacts to long-term financial value creation.
We’ve developed our Total Value Framework using traditional ESG scores and ranks—
to address the current deficiencies in ESG which, again, may as well be emojis, as
data and to help investors generate a lasting they are just as difficult to incorporate into
impact on corporate behavior and robust spreadsheets or algorithms. In service of
long-term financial returns. To that end, we this, we use independent sources and
have worked to develop a unique method estimates to assess the firm-level cost
of measurement that focuses on both the of emissions, resource use, waste, social
value that companies create or destroy for practices, and a host of other ESG factors.
shareholders and stakeholders, as well as on
• Value for shareholders: Armed with this
the connection between these two groups.
new data, we can proceed to focus on
• Value for stakeholders: Through the how the value delivered to stakeholders
Total Value Framework, we attempt affects the value a company is then able to
to measure the value that companies deliver to its shareholders. This forces us to
create or destroy for both shareholders examine drivers like potential regulation,
and stakeholders—their employees, changes in customer or employee
customers, and communities, as well as preferences, technological disruption, and
the environment. We try, where possible, other relevant contributors to a company’s
to quantify the impact in dollars instead of risk or growth.
25
For example, we can show that variations methodology integrates reliable ESG data into
in the level of value created or destroyed for mainstream financial reporting and attempts
stakeholders strongly predict future shifts in to understand and accurately predict how
the company’s financial value, including in ESG performance affects future valuations.
revenues, worker productivity, earnings, net
We put a dollar value on the uncompensated
income, market capitalization, and earnings
consequences of production or consumption
multiples. Indeed, the association between
that impact third parties and are not
stakeholder value and these financial
reflected in market prices—so-called
outcomes has turned out to be far stronger
negative and positive externalities—such as
and more robust than have the correlations
the costs of respiratory disease from burning
observed between traditional ESG metrics
diesel, or the costs of lost biodiversity when
and these same outcomes.
forests are cleared for palm oil production.
Crucially, the framework’s analysis informs An understanding of such “externalities” is
our decisions as investors—the investments critical to any ESG approach.
we make, as well as what we do as owners
By measuring the financial value of these
once we make those investments. We believe
externalities, in terms of both positive and
investors can only effect lasting change when
negative corporate impacts, the Total Value
they work as active owners. With the Total
Framework allows much better comparisons
Value Framework, we come armed with an
between the performance of firms over time
approach that is rooted in data, connected
and across industries. That, in turn, leads
to value, integrated with our investing
to better predictions of their impact on
process, and focused on change. We also
future market valuations, which makes it
stress the importance of attribution–in our
easier to identify the conditions under which
view, understanding causal factors is more
ESG performance is likely to be financially
important than constructing a deterministic
material. Perhaps most importantly, the
model.
monetization of ESG performance makes
By embracing these principles, we believe it possible to fully integrate ESG factors into
ESG investing can harness private capital mainstream financial analysis and help
on the scale needed to address systemic to overcome some of the inadequacies of
challenges like climate change. Only then subjective and biased data.
will the potential of ESG funds translate into
Remedies for significant negative
the better financial returns and the corporate,
externalities often involve imposing costs
societal, and environmental outcomes they
on the “offending” producers or consumers,
were always meant to deliver.
a process referred to as “internalization.”
This most commonly takes the form of
Better analysis government regulation. For example, the
Rather than use a performance ranking Clean Air and Clean Water acts, passed
based on another set of subjective criteria, our in the US in the 1960s and 1970s, required
26
polluting businesses to reduce pollution Similarly we believe that firms that create
levels and to pay for some of the costs significant positive externalities will be
associated with residual pollution. Also rewarded over time as regulators treat them
driving internalization are consumer favorably, as employee satisfaction grows,
pressure and purchasing decisions, which and as customers become more inclined to
are often informed by public campaigns from buy their products. Figure 6 illustrates the
NGOs focused on environmental and social relationship between the total externalities
issues. Further internalization comes when imposed on stakeholders and the costs
local communities successfully sue major internalized by a business.
corporations for unlawful dumping of waste,
Figure 7 provides an alternative way of looking
or when they demand compensation and
at the relationship between stakeholder
damages after high-profile environmental
impacts and shareholder value at the firm
incidents, and companies are then hit with level. In the “current state,” the maximization
the associated compensation costs and of profits for shareholders is achieved at the
punitive damages. Environmental decline expense of workers, customers, and suppliers.
on its own can lead to internalization: This leads to a stakeholder backlash (bottom
witness the disruption to operations, the right) and an erosion of shareholder value.
price volatility in agricultural commodities, By shifting to a more positive stakeholder
and other costs stemming from droughts, orientation (top right) a business can deliver
floods, soil erosion, and pests. sustainable shareholder returns.
Total Benefits
s
Be nefit
rnal
Exte
Business Revenues
Today Time
Figure 6: Illustration—internalization of positive externalities over time
27
Current state Future state

Shareholders
Broader
societal Workers
impacts
Shareholders Civil
Firm Customers
society
Broader
societal Workers
impacts
Government Suppliers
Strategy shift to build long-term

stakeholder (and shareholder) Community
value
Civil
society
Firm Customers
Status quo focus on short- Shareholders

term shareholder value triggers
stakeholder backlash and long-term Broader
shareholder value erosion societal Workers
impacts
Civil
society
Firm Customers
Community
Community
Figure 7: Illustration of the long-term effects of narrow profit
maximization versus positive stakeholder orientation
By measuring net externalities in addition reduced by the amount of the externality

to shareholder value, Engine No. 1’s Total that is internalized.
Value Framework captures the positive
Conversely, a business that creates net
and negative externalities generated by a
positive value for stakeholders would expect
company throughout its value chain. As
higher long-term shareholder value. This is
shown in Figure 8, net externalities are the
because its net externalities are positive and
sum of negative and positive externalities.
a proportion of this may be internalized over
For an unsustainable business, net
time, as shown in Figure 9.
externalities are negative and stakeholder
value will be lower than shareholder
value. In the medium term some of this
The elements of our framework
net externality is likely to be internalized, Engine No. 1 uses independent sources
reducing shareholder value, while some and estimates to assess the firm-level cost
may remain unaccounted for as a residual of emissions, resource use, waste, social
externality. The final bar illustrates the effect practices, and a host of other ESG factors.
on long-term shareholder value, which is
28
Negative Net Internalized

externalities externalities externality
Non-sustainable value
business
Value
Residual
externality
Positive value
externalities
Shareholder Stakeholder Long-term

value value shareholder value
Figure 8: Long-term shareholder value for an unsustainable business
Sustainable
business
Value
Shareholder Stakeholder Long-term

value value shareholder value
Figure 9: Long-term shareholder value for a sustainable business
29
The framework utilizes a number of objective audited data remains the biggest
environmental and social factors: Climate obstacle to assessing a company’s ESG
Change, Air Quality, Water Consumption, performance. Further, we believe a lack of
Land Use, Waste, Human Rights, visibility or accountability as it concerns
Scope 3 emissions makes mainstream ESG
Corruption/Bribery/Fraud, Community
an arbitrary measure, at best. As recently
Relations, Customer Privacy/Data Security,
as the start of 2020, for example, neither BP
Product Quality/Safety, Employee Health/
nor ExxonMobil had published downstream
Safety, Training/Development, and emissions data relating to sales of oil and
Diversity/Inclusion, among others. The gas. Where companies do not report the
evolving framework is comprehensive across relevant information, we’re forced to impute
the supply chain, capturing the financial data from models that draw upon sources
costs of upstream and downstream impacts such as the United Nations, the International
as well as those stemming from the firm’s Labor Organization, the Organization for
Economic Cooperation and Development,
own operations. As we refine our investment
or the European Union. In the absence of
strategies by sector and incorporate more
reliable primary data, we sometimes have to
attribution measures, the power of the Total
settle for adjusted industry averages of ESG
Value Framework will become stronger. performance. In all cases, we validate the
results to identify outliers or discontinuous
Some factors are easier to measure than
jumps and seek out alternative algorithms
others. Tracking the cost of greenhouse
to fill in gaps.
gases (GHGs) is relatively easy: techniques
are increasingly available for converting
company emissions into tons of carbon Better investing
dioxide equivalent and calculating the effect
on global welfare. Similarly, it’s possible to The magnitude of these net externalities
compute the social cost of other forms of varies significantly across sectors, with
air pollution, negative effects on land and some showing ten times other sectors’
biodiversity, waste and water consumption, externalities per dollar of revenue. The
the adverse health consequences of obvious question is: what correlation, if
tobacco and alcohol production, and any, can we detect between a company’s
workplace injuries and fatalities. The social externalities and its shareholder value?
consequences of wages that fall below Our initial analysis strongly supports a far
a minimum standard, or the financial more consistent and powerful association
benefits of worker training and voluntary than that found via traditional ESG data. It
community philanthropic expenditure, can shows that the difference between a firm’s
also be monetized. Total Value and its shareholder value, and
Of all the factors in our framework, GHG changes in those net externalities relative
data may be the most widely reported, to industry peers, are strongly indicative
either by companies themselves or by a host of future changes in financial outcomes.
of specialist data providers. But a lack of Between 2010 and 2019, for example, the
30
Top ranked by TV impacts

Bottom ranked by TV impacts
500%
400%
Cumulative stock performance (2010-2019)
300%
200%
100%
0%
0 5 10
-100%
-200%
Rank
Figure 10: Cumulative performance of the S&P 500 firms with the largest and smallest negative impacts
ten S&P 500 firms with the largest negative The pattern is similar when the Engine
impacts, as ranked in 2019 (“Top Ranked by No. 1 methodology is applied to the best and
TV Impacts”), substantially underperformed worst performers in each sector. As Figure
the market; the ten companies with the 12 shows, in all but one sector, the worst
smallest negative impacts (“Bottom Ranked performing firms on Total Value—those with
by TV Impacts”), meanwhile, significantly the absolute highest negative externalities
outperformed (see Figure 10). as measured by the Total Value Framework,
shown in Figure 12 on the left—dramatically
By contrast, using traditional ESG measures
underperformed the median firm in their
to analyze these same groups of winners
sector, in the majority of cases by 50% over
and losers found no consistent patterns or
the ensuing decade.
correlations.
31
Top ranked by TVL-Insight SASB aII categories Top ranked by TVL-Insight SASB materiality
Bottom ranked by TVL-Insight SASB aIl categories Bottom ranked by TVL-Insight SASB materiality
150% 100%
100%
50%
50%
0%
0 2 4 6 8 10
0%
0 2 4 6 8 10
-50%
-50%
-100%
-100%
-150%
-150%
-200%
-200%
-250% Rank -250% Rank
Top ranked by Refinitiv ESG score Top ranked by MSCI average of E, S, & G scores
Bottom ranked by Refinitiv ESG score Bottom ranked by MSCI average of E, S, & G scores
150% 250%
100% 200%
50% 150%
0% 100%
0 2 4 6 8 10
-50%
50%
-100% 0%
0 2 4 6 8 10
-150% -50%
-200% -100%
Rank Rank
-250% -150%
Figure 11: Cumulative performance of the top and bottom S&P 500 firms ranked by traditional ESG measures
32
Median vs. companies with absolute highest Median vs. 5th percentile of companies with highest
Total Value within sector in 2010 Total Value within sector in 2010
Utilities Utilities
Real Estate Real Estate
Materials Materials
Information Technology Information Technology
Industrials Industrials
Health Care Health Care
Financials Financials
Energy Energy
Consumer Staples Consumer Staples
Consumer Discretionary Consumer Discretionary
Communication Services Communication Services
-200% -150% -100% -50% -0% 50% 100% -200% -150% -100% -50% -0% 50% 100%
Median by sector Companies with absolute highest Total Value within sector Median by sector 5th percentile of companies with highest Total Value within sector
Figure 12: Cumulative relative performance vs. S&P 500: 2010-2020 by sector
Negative effect of environmental intensities on financial Positive effect of D&I and human rights on the
metrics distribution distribution of financial metrics
Partial correlation coefficients
Partial correlation coefficients
5% 15% 25% 35% 45% 55% 65% 75% 85% 95%
5% 15% 25% 35% 45% 55% 65% 75% 85% 95%
Quantities of financial metrics Quantities of financial metrics
Market cap EBITDA Net income Market cap EBITDA Net income
Figure 13: Financial performance related to Total Value in both environmental and social dimensions
33
If we build on the discussion on the preceding data framework and it holds assumptions
pages, we can look at illustrative returns using over the time period constant, we can still
the Total Value Framework. see in the chart that the framework can be
an important and impactful methodology
In the chart below (see Figure 14), we
to deploy towards generating favorable
analyzed the performance of S&P 500 firms
financial returns, while at the same time
between December 2, 2011 and August 9,
quantifying the requisite ESG impact (as
2021 using the Total Value Framework and
opposed to the aforementioned ranking and
separated the firms into quintiles. Quintile
rating methods). Subsequent versions of the
designation on this chart is represented with
Total Value Framework will seek to employ a
‘1’ representing firms with the lowest Total
deeper sector- specific analysis, with better
Value Score (or largest negative impacts)
defined weighting schemes and more direct
which substantially underperformed the
attribution statistics. We are seeking to bring
benchmark, and ‘5’ representing the highest
a new framework to ESG investing which may
Total Value Score (or smallest negative
carry significant upside potential.
impacts) which outperformed the benchmark.
While this does not account for an evolving
Figure 14: Illustrative return based on Total Value Score (from 1 to 5) vs. S&P 500
$6
$5
Illustrative return per US dollar
invested on January 1, 2012
$4
$3
$2
$1
$0
$-1
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
1 2 3 4 5 S&P 500
Note: Provided for illustrative purposes only. The chart does not represent the performance results of any existing or proposed
investment vehicle managed by Engine No. 1. The above chart represents the application of the Total Value Framework to
approximately 700 companies included in the S&P 500 Index from December 2, 2011 – August 9, 2021 to demonstrate the correlation
of performance of companies with lower and higher Total Value Scores.
The Total Value Framework employs a variety of ESG-related data factors to quantify and connect the material impact of a company
to financial performance. The framework identifies material and high-impact actions a company can take, and assigns dollar values
to those actions, highlighting where a business is under or over-valued based on impact. This process determines each company’s
Total Value Score. The companies were then separated into quintiles, with Band 1 including the companies having the lowest Total
Value Score, and Band 5 having the highest Total Value Score. Portfolio quintile and S&P index composition adjusted annually.
The chart shows the hypothetical performance of an investment in December 2, 2011 of $1 USD per each Band as of August 9,
2021 and assumes that the basket of securities composing each quintile is rebalanced on January 1 of each year. Hypothetical
performance is not actual performance and has inherent limitations and should not form the basis for an investment decision.
None of the information set forth above constitutes an offer to purchase or an offer to sell, or a promotion or recommendation of,
any security, financial instrument, product or trading strategy. Past performance is not indicative or a guarantee of future results.
Please see “Important Information” at the end of this White Paper.
Additional information regarding Engine No. 1’s Total Value Framework and methodology is available upon request.
34
Our analysis further shows that the strength develop them ourselves. In this way we can
of the correlations increases across each realize the full potential of the framework.
decile, with the strongest relationship
More advanced techniques based on
observed among top-performing firms.
artificial intelligence will provide further
The lesson is clear: mitigating negative
opportunities for improvement. We continue
externalities or contributing positive ones
to experiment with data imputation to plug
is a key differentiator of top-performing
holes. It’s important to note that missing
firms, and significantly so, for over half the
information about ESG is far from random:
companies in the S&P 500.
high ESG-performing firms are generally
among the first to report, with laggards
Better owners likely to be last. We are also trying to better
track the speed with which companies
How does the data offered by the Total Value
internalize the externalities identified
Framework improve the ESG investing
by shareholders, and we furthermore
strategies discussed earlier in this paper?
hope to identify new factors that will
By monetizing the impact of ESG, investors
drive the internalization of externalities.
will be able to integrate the new data into
These include but are not limited to the
traditional financial analysis without
development of more focused signals of
having to carry out the bespoke and time-
impending legislative, regulatory, or legal
consuming assessments required by current
shifts, as well as indications of pressure from
ESG data and methodologies.
within a company’s supply chain—or the
The objective nature of the data will also specific geographic communities in which
allow Total Value accounts to be properly a company operates—to address costs
audited, which stands in contrast to the imposed on stakeholders.
voluntary or custom third-party reporting
More fundamentally, we would like to
that is common at the moment.
turn the industry away from separating
While Engine No. 1’s Total Value Framework ESG analysis from other financial and
represents a major breakthrough, there is operational analysis. We aim to encourage
substantial room for improvement. Of bespoke integration of the two instead,
the pathways between stakeholder and shifting the focus to the dollar value of a
shareholder value we’ve identified, not firm’s Total Value creation or destruction
all can be integrated into the framework and the likelihood of internalization by
because of existing data limitations. Looking shareholders.
ahead, we aim to find new sources of Reframing the ESG integration process is
alternative data, either procuring these from consistent with the recent emphasis on
third-party providers or, when necessary, materiality, though the transformation will
working independently or with partners to require a deep cultural shift.
35
A historical perspective on the ESG By embracing the principles behind the

movement, such as what we have provided, Total Value Framework, we believe ESG
highlights why the market requires a radical investing can harness private capital on the
shift in its approach to ESG measurement. scale needed to address systemic challenges
The monetization of ESG performance, like climate change. Only then can the
as provided by Engine No. 1’s Total Value potential of ESG funds translate into the
Framework, is an important step in this
better financial returns and the corporate,
evolution. We anticipate that the strong,
societal, and environmental outcomes they
albeit preliminary, new evidence of the
were always meant to deliver.
links between value and values will spur
interest among investors, academics, and
policymakers as we advance Engine No. 1’s
Total Value methodology.
Conclusion:
Building a better way
Interest in responsible and sustainable
investing has never been greater. Yet many
of the individuals committing their money,
companies striving to mend their ways,
and governments seeking progress through
new regulations are growing frustrated by
the results.
36
i Eccles, R. G., Lee, L.-E., & Stroehle, J. C. 2020. The Social Origins of ESG: An Analysis of Innovest and KLD. Organization & Environment, 33(4): 575-596, Townsend, B. 2020.
From SRI to ESG: The Origins of Socially Responsible and Sustainable Investing. The Journal of Impact and ESG Investing, 1(1): 10-25.
ii Hartzmark, S. M., & Sussman, A. B. 2019. Do Investors Value Sustainability? A Natural Experiment Examining Ranking and Fund Flows. The Journal of Finance, 74(6): 2789-
2837, Renneboog, L., Ter Horst, J., & Zhang, C. 2011. Is Ethical Money Financially Smart? Nonfinancial Attributes and Money Flows of Socially Responsible Investment Funds.
Journal of Financial Intermediation, 20(4): 562-588, Riedl, A., & Smeets, P. 2017. Why Do Investors Hold Socially Responsible Mutual Funds? The Journal of Finance, 72(6):
2505-2550.
iii Borgers, A., Derwall, J., Koedijk, K., & Ter Horst, J. 2015. Do Social Factors Influence Investment Behavior and Performance? Evidence From Mutual Fund Holdings. Journal
of Banking & Finance, 60: 112-126, Eccles, R. G., Lee, L.-E., & Stroehle, J. C. 2020. The Social Origins of ESG: An Analysis of Innovest and KLD. Organization & Environment,
33(4): 575-596, Humphrey, J. E., & Tan, D. T. 2014. Does it Really Hurt to be Responsible? Journal of Business Ethics, 122(3): 375-386, Townsend, B. 2020. From SRI to ESG:
The Origins of Socially Responsible and Sustainable Investing. The Journal of Impact and ESG Investing, 1(1): 10-25.
iv Auer, B. R., & Schuhmacher, F. 2016. Do Socially (Ir)responsible Investments Pay? New Evidence from International ESG Data. The Quarterly Review of Economics and
Finance, 59: 51-62, Capelle-Blancard, G., & Monjon, S. 2014. The Performance of Socially Responsible Funds: Does the Screening Process Matter? European Financial
Management, 20(3): 494-520, Cortez, M. C., Silva, F., & Areal, N. 2012. Socially Responsible Investing in the Global Market: The Performance of US and European Funds.
International Journal of Finance & Economics, 17(3): 254-271, El Ghoul, S., & Karoui, A. 2017. Does Corporate Social Responsibility Affect Mutual Fund Performance and
Flows? Journal of Banking & Finance, 77: 53-63, Munoz, F., Vargas, M., & Marco, I. 2014. Environmental Mutual Funds: Financial Performance and Managerial Abilities.
Journal of Business Ethics, 124(4): 551-569, Renneboog, L., Ter Horst, J., & Zhang, C. 2008. The Price of Ethics and Stakeholder Governance: The Performance of Socially
Responsible Mutual Funds. Journal of Corporate Finance, 14(3): 302-322.
v Lee, D. D., Humphrey, J. E., Benson, K. L., & Ahn, J. Y. 2010. Socially Responsible Investment Fund Performance: The Impact of Screening Intensity. Accounting & Finance,
50(2): 351-370, Renneboog, L., Ter Horst, J., & Zhang, C. 2008. The Price of Ethics and Stakeholder Governance: The Performance of Socially Responsible Mutual Funds.
Journal of Corporate Finance, 14(3): 302-322.
vi Nofsinger, J., & Varma, A. 2014. Socially Responsible Funds and Market Crises. Journal of Banking & Finance, 48: 180-193.
vii Blitz, D., & Swinkels, L. 2020. Is Exclusion Effective? The Journal of Portfolio Management, 46(3): 42-48, Broccardo, E., Hart, O. D., & Zingales, L. 2020. Exit vs. Voice: National
Bureau of Economic Research, Dyck, A., Lins, K. V., Roth, L., & Wagner, H. F. 2019. Do Institutional Investors Drive Corporate Social Responsibility? International Evidence.
Journal of Financial Economics, 131(3): 693-714, Jahnke, P. 2019. Ownership Concentration and Institutional Investors’ Governance Through Voice and Exit. Business and
Politics, 21(3): 327-350, Whelan, T., Atz, U., Van Holt, T., & Clark, C. 2021. ESG and Financial Performance: NYU Stern Center for Sustainable Business.
viii Amon, J., Rammerstorfer, M., & Weinmayer, K. 2020. Passive ESG Portfolio Management - The Benchmark Strategy for Socially Responsible Investors. Available at SSRN:
https://ssrn.com/abstract=3400628 or http://dx.doi.org/10.2139/ssrn.3400628, Conen, R., Hartmann, S., & Rudolf, M. 2020. Going Green Means Being in the Black. Available
at SSRN: https://ssrn.com/abstract=3646015 or http://dx.doi.org/10.2139/ssrn.3646015, Geczy, C. C., Guerard, J. B., & Samonov, M. 2020. Warning: SRI Need Not Kill Your
Sharpe and Information Ratios—Forecasting of Earnings and Efficient SRI and ESG Portfolios. The Journal of Investing, 29(2): 110-127, Hanicova, D., & Vojtko, R. 2020.
Backtesting ESG Factor Investing Strategies. Available at SSRN: https://ssrn.com/abstract=3633303 or http://dx.doi.org/10.2139/ssrn.3633303, Kaiser, L. 2020. ESG
Integration: Value, Growth and Momentum. Journal of Asset Management, 21(1): 32-51, Madhavan, A., Sobczyk, A., & Ang, A. 2021. Toward ESG Alpha: Analyzing ESG Exposures
Through a Factor Lens. Financial Analysts Journal, 77(1): 69-88, Maiti, M. 2020. Is ESG the Succeeding Risk Factor? Journal of Sustainable Finance & Investment: 1-15,
Nagy, Z., Kassam, A., & Lee, L.-E. 2016. Can ESG Add Alpha? An Analysis of ESG Tilt and Momentum Strategies. The Journal of Investing, 25(2): 113-124, Pedersen, L. H.,
Fitzgibbons, S., & Pomorski, L. 2020. Responsible Investing: The ESG-efficient Frontier. Journal of Financial Economics, Steen, M., Moussawi, J. T., & Gjolberg, O. 2020. Is
There a Relationship Between Morningstar’s ESG Ratings and Mutual Fund Performance? Journal of Sustainable Finance & Investment, 10(4): 349-370.
ix Clark, C., & Lalit, H. 2020. ESG Improvers: An Alpha Enhancing Factor: Rockefeller Asset Management, Steen, M., Moussawi, J. T., & Gjolberg, O. 2020. Is There a Relationship
Between Morningstar’s ESG Ratings and Mutual Fund Performance? Journal of Sustainable Finance & Investment, 10(4): 349-370.
x Serafeim, G. 2020. Public Sentiment and the Price of Corporate Sustainability. Financial Analysts Journal, 76(2): 26-46.
xi Breedt, A., Ciliberti, S., Gualdi, S., & Seager, P. 2019. Is ESG an Equity Factor or Just an Investment Guide? The Journal of Investing, 28(2): 32-42, Drei, A., Le Guenedal,
T., Lepetit, F., Mortier, V., Roncalli, T., & Sekine, T. 2019. ESG Investing in Recent Years: New Insights from Old Challenges. SSRN: https://ssrn.com/abstract=3683469 or
http://dx.doi.org/10.2139/ssrn.3683469, Filbeck, A., Filbeck, G., & Zhao, X. 2019. Performance Assessment of Firms Following Sustainalytics ESG Principles. The Journal
of Investing, 28(2): 7-20, Verheyden, T., Eccles, R. G., & Feiner, A. 2016. ESG for All? The Impact of ESG Screening on Return, Risk, and Diversification. Journal of Applied
Corporate Finance, 28(2): 47-55.
xii Messina, J. 2017. Measuring Intangibles: RobecoSAM’s Corporate Sustainability Assessment Methodology: RobecoSAM AG.
xiii Melas, D., Nagy, Z., & Kulkarni, P. 2016. Factor Investing and ESG Integration: MSCI.
xiv Attig, N., El Ghoul, S., Guedhami, O., & Suh, J. 2013. Corporate Social Responsibility and Credit Ratings. Journal of Business Ethics, 117(4): 679-694, Bae, S. C., Chang, K., & Yi,
H.-C. 2016. The Impact of Corporate Social Responsibility Activities on Corporate Financing: A Case of Bank Loan Covenants. Applied Economics Letters, 23(17): 1234-1237,
Bae, S. C., Chang, K., & Yi, H.-C. 2018. Corporate Social Responsibility, Credit Rating, and Private Debt Contracting: New Evidence From Syndicated Loan Market. Review of
Quantitative Finance and Accounting, 50(1): 261-299, Bae, S. C., Chang, K., & Yi, H.-C. 2018. Corporate Social Responsibility, Credit Rating, and Private Debt Contracting:
New Evidence from Syndicated Loan Market. Review of Quantitative Finance and Accounting, 50(1): 261-299, Bahra, B., & Thukral, L. 2020. ESG in Global Corporate
Bonds: The Analysis Behind the Hype. The Journal of Portfolio Management, 46(8): 133-147, Chava, S. 2014. Environmental Externalities and Cost of Capital. Management
Science, 60(9): 2223-2247, Desclee, A., Dynkin, L., Hyman, J., & Polbennikov, S. 2016. Sustainable Investing and Bond Returns: Barclays Research, Impact Series, El Ghoul,
S., Guedhami, O., Kwok, C. C., & Mishra, D. R. 2011. Does Corporate Social Responsibility Affect the Cost of Capital? Journal of Banking & Finance, 35(9): 2388-2406, Goss, A.,
& Roberts, G. S. 2011. The Impact of Corporate Social Responsibility on the Cost of Bank Loans. Journal of Banking & Finance, 35(7): 1794-1810, Landry, E., Castillo-Lazaro,
M., & Lee, A. 2017. Connecting ESG and Corporate Bond Performance, MIT Sloan Management School & Breckinridge Capital Advisors Report, Nguyen-Taylor, K., Naranjo,
I., & Roy, C. 2015. The ESG Advantage in Fixed Income Investing: An Empirical Analysis. Calvert Investments, Polbennikov, S., Desclée, A., Dynkin, L., & Maitra, A. 2016. ESG
Ratings and Performance of Corporate Bonds. The Journal of Fixed Income, 26(1): 21, Reznick, M., & Viehs, M. 2017. Pricing ESG Risk in Credit Markets. Hermes Investment
Management Report, Sharfman, M. P., & Fernando, C. S. 2008. Environmental Risk Management and the Cost of Capital. Strategic Management Journal, 29(6): 569-592.
xv Alessandrini, F., & Jondeau, E. 2020. ESG Investing: From Sin Stocks to Smart Beta. The Journal of Portfolio Management, 46(3): 75-94, Giese, G., Lee, L.-E., Melas, D., Nagy,
Z., & Nishikawa, L. 2019. Foundations of ESG Investing: How ESG Affects Equity Valuation, Risk, and Performance. The Journal of Portfolio Management, 45(5): 69-83,
Jacobsen, B., Lee, W., & Ma, C. 2019. The Alpha, Beta, and Sigma of ESG: Better Beta, Additional Alpha? The Journal of Portfolio Management, 45(6): 6-15, Jagannathan, R.,
Ravikumar, A., & Sammon, M. 2017. Environmental, Social, and Governance Criteria: Why Investors Are Paying Attention. NBER Working Paper, 24063.
xvi Kumar, R. 2019. ESG: Alpha or Duty? The Journal of Index Investing, 9(4): 58-66.
xvii Evans, R. 2018. How Socially Responsible Investing Lost Its Soul. Bloomberg Businessweek(December 18).
xviii Koller, T., Nuttall, R., & Henisz, W. 2019. Five Ways that ESG Creates Value. The McKinsey Quarterly(Nov 14, 2019).
xix Nelson, T. 2018. ESG, Climate Change Risk and Disclosure. Governance Directions, 70(11): 705.
xx Cappucci, M. 2018. The ESG Integration Paradox. Journal of Applied Corporate Finance, 30(2): 22-28.
xxi CalPERS. 2015. Focus List Program.
xxii Shekita, N. 2020. Interventions by Common Owners. Available at SSRN.
xxiii Dimson, E., Karakaş, O., & Li, X. 2020. Coordinated Engagements. Available at SSRN 3209072.
xxiv Doidge, C., Dyck, A., Mahmudi, H., & Virani, A. 2019. Collective Action and Governance Activism. Review of Finance, 23(5): 893-933.
37
TRANSFORMING ACTIVE OWNERSHIP
Important Information
Engine No. 1 LLC (“Engine No. 1”) is registered as an investment adviser with the U.S. Securities and
Exchange Commission (the “SEC”). Registration with the SEC or with any state securities authority
does not imply a certain level of skill or training. This white paper does not constitute an offer to sell
or a solicitation to buy any securities in any investment vehicle managed by Engine No. 1 and may
not be relied upon in connection with any offer or sale of securities. Any offer to buy interests in an
investment vehicle will be made pursuant to the delivery of the related organizational and offering
documents of such investment vehicle. Investing in securities and other financial instruments entails
substantial risk, including the possible loss of principal.
This white paper is being provided for informational purposes only, is not a research report and should
not be considered investment advice. Engine No. 1 is not acting and does not purport to act in any way
as an adviser or in a fiduciary capacity vis-a-vis any recipient of this white paper.
The information and opinions contained in this white paper are for background purposes only, are
subject to change without notice, and Engine No. 1 has no obligation to update it. No representation,
warranty or undertaking, express or implied, is given as to the accuracy or completeness of the infor-
mation or opinions contained in this white paper by Engine No. 1, any of their affiliates or any of their
respective members, partners, directors, officers, employees and agents and no liability is accepted
by such persons for the accuracy or completeness of any such information or opinions. In particular,
but without prejudice to the generality of the foregoing, no representation or warranty is given as
to the achievement or reasonableness of any returns, projections, estimates, valuations or prospects
contained in this white paper or in such other written or oral information. This white paper contains
information and opinions and has been prepared in good faith on the basis of reasonable, honest-
ly-held beliefs. The contents of this white paper are not to be construed as legal, business, financial,
or tax advice, and you should consult your own advisors on such matters as you deem appropriate.
This white paper contains forward-looking statements and such forward looking statements involve
risks and uncertainties, and actual results may differ materially from any expectations, projections, or
predictions made or implicated in such forward-looking statements. Unless otherwise indicated, the
information contained herein is current as of the date indicated on the cover of this white paper. Cer-
tain parts of this white paper contain simplified presentations of complex processes. The investment
process and program of Engine No. 1 for any particular product or advice given may differ materially
from what is stated herein. There is no obligation to update, modify or amend this white paper or to
otherwise notify a reader in the event that any matter stated herein, or any opinion, projection, fore-
cast, or estimate set forth herein, changes or subsequently becomes inaccurate.
© 2021 Engine No. 1 LP

Engine No. 1 Total Value Framework

Uploaded by

Copyright:

Available Formats

Engine No. 1 Total Value Framework

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Engine No. 1 Total Value Framework

Uploaded by

Copyright:

Available Formats

INTRODUCTION

This paper will explore:

host of other ESG factors. to measuring ESG performance in scores or

regulation, changes in customer or employee between ESG and performance, screening

preferences, technological disruption, and or exclusionary strategies will continue to

risk or growth. appraisal. Without it, we face the danger

ESG emerged into today’s investing mainstream from old roots.

Exclusionary screens the South African apartheid and the

These investors’ impact on corporate However not all studies corroborate

in contrast with an exclusionary investor, standalone factor in investment portfolios.

High Medium Low

fundamental analysis requires a bottom- training is not only time-consuming but is

Conclusion: company’s sector, ratings, or scores. But the

Without objective, consistently available data on ESG performance

into their investment strategies. This presents a

Figure 2: Low correlations across data providers in ESG ratings

MSCI ASSET4 Sustainalytics Reprisk

JP MORGAN BERKSHIRE HATHAWAY

Rating agency 1 Rating agency 2 Rating agency 3 Rating agency 4

Figure 3: Divergence in ESG ratings across large, global companies

Figure 4: Correlation at aggregate ESG level and at E, S, and G levels

SA - VI SA - KL SA - RS SA -A4 VI -KL VI - RS VI -A4 KL -RS KL - A4 RS - A4

Air Quality 0.42 0.42

Employee Engagement, Diversity

Materials Sourcing & Efficiency 0.59 0.33 0.34 0.42

Competitive Behavior 0.55 -0.04 -0.05 0.15

Systemic Risk Management 0.26 0.26

Sector-specific materiality determining sector-specific materiality.

The Materiality Map encompasses thirty

available.”10 The tool is regularly updated actionable insights around a company’s

The adoption of the concept of materiality—

Figure 6: Illustration—internalization of positive externalities over time

Current state Future state

Strategy shift to build long-term

Status quo focus on short- Shareholders

By measuring net externalities in addition reduced by the amount of the externality

Negative Net Internalized

Shareholder Stakeholder Long-term

Figure 8: Long-term shareholder value for an unsustainable business

Shareholder Stakeholder Long-term

Figure 9: Long-term shareholder value for a sustainable business

the adverse health consequences of obvious question is: what correlation, if

Top ranked by TV impacts

-250% Rank -250% Rank

Real Estate Real Estate

Information Technology Information Technology

Health Care Health Care

Consumer Staples Consumer Staples

Consumer Discretionary Consumer Discretionary

Communication Services Communication Services

Partial correlation coefficients

5% 15% 25% 35% 45% 55% 65% 75% 85% 95%

5% 15% 25% 35% 45% 55% 65% 75% 85% 95%

Quantities of financial metrics Quantities of financial metrics

A historical perspective on the ESG By embracing the principles behind the

© 2021 Engine No. 1 LP

You might also like