It is no magic wand but it is a key part of the analytical toolkit for investors and companies
Head of HSBC's Climate Change Centre
Awareness of environmental, social and governance – ESG – issues among the general public has grown rapidly in recent years. Consumers increasingly consider sustainability, diversity and labour conditions when they buy.
Companies need to take that into account – but so do investors. The incorporation of ESG analysis into investment decision-making will only grow. However, we need to consider what this means for different stakeholders.
Fund managers face growing pressure from their clients to have an ESG framework that allows them to incorporate the issues into their investment analysis and decisions. Companies will be subject to more questions and scrutiny from investors, facing demands to disclose timely, relevant information and data. And regulators are increasingly embracing ESG compliance, moving from voluntary disclosure to ‘comply-or-explain’ and even some mandatory requirements.
HSBC’s ESG Integrated report series has looked at sectors from retailing to telecoms to identify the issues relevant to each industry, highlighting why these issues are important, what information and data is available, and how ESG issues can affect a sector in the future.
But identification is just the first step. Ultimately, we plan to fully integrate ESG issues into our stock coverage framework, adjusting our financial forecasts according to whether these issues are risks or opportunities.
Environmental, social and governance issues affect the future course of a company – positively or negatively – but may vary across different time horizons and depend on how well the business addresses the issue.
ESG is evolving rapidly. We advocate using an integrated approach that uses an analytical framework to enhance the existing investment decision-making process. Rather than assigning scores or ratings, our integrated approach focuses on the issues that are, or will likely become, material for businesses.
Scores and ratings can be a useful starting point to help identify those areas that require more attention and deeper analysis but only if they are transparent and consistent. Different ESG issues are more, or less, material to different sectors, for instance; the availability of information varies hugely and the quality of data for specific issues is inconsistent.
For example, the water policy of a technology firm cannot be compared with the safety record of a mining company or gender diversity at a food retailer be compared with working conditions at a fashion house. Even within a single ESG issue, the importance of water usage at an internet firm differs from a beverage company’s usage. Thus any weighting applied to an ESG issue should be dependent on its materiality to a company over a time frame.
Reducing ESG to a score or rating detracts from the qualitative analysis of how the issues can affect the risks and opportunities facing a company, and investment analysis should be forward looking while data is historical.
ESG integration allows greater focus on issues more material to a sector or company and can better capture the sustainability risks and opportunities. It can also be incorporated into existing investment analysis, be included in financial modelling, is forward looking and encourages understanding of the qualitative aspects of a business.
First published 2 November 2020.
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The following analyst(s), economist(s), or strategist(s) who is(are) primarily responsible for this report, including any analyst(s) whose name(s) appear(s) as author of an individual section or sections of the report and any analyst(s) named as the covering analyst(s) of a subsidiary company in a sum-of-the-parts valuation certifies(y) that the opinion(s) on the subject security(ies) or issuer(s), any views or forecasts expressed in the section(s) of which such individual(s) is(are) named as author(s), and any other views or forecasts expressed herein, including any views expressed on the back page of the research report, accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: Wai-Shin Chan, CFA
Equities: Stock ratings and basis for financial analysis
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From 23rd March 2015 HSBC has assigned ratings on the following basis:
The target price is based on the analyst’s assessment of the stock’s actual current value, although we expect it to take six to 12 months for the market price to reflect this. When the target price is more than 20 per cent above the current share price, the stock will be classified as a Buy; when it is between 5 per cent and 20 per cent above the current share price, the stock may be classified as a Buy or a Hold; when it is between 5 per cent below and 5 per cent above the current share price, the stock will be classified as a Hold; when it is between 5 per cent and 20 per cent below the current share price, the stock may be classified as a Hold or a Reduce; and when it is more than 20 per cent below the current share price, the stock will be classified as a Reduce.
Our ratings are re-calibrated against these bands at the time of any 'material change' (initiation or resumption of coverage, change in target price or estimates).
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Prior to this date, HSBC’s rating structure was applied on the following basis:
For each stock we set a required rate of return calculated from the cost of equity for that stock’s domestic or, as appropriate, regional market established by our strategy team. The target price for a stock represented the value the analyst expected the stock to reach over our performance horizon. The performance horizon was 12 months. For a stock to be classified as Overweight, the potential return, which equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated, had to exceed the required return by at least 5 percentage points over the succeeding 12 months (or 10 percentage points for a stock classified as Volatile*). For a stock to be classified as Underweight, the stock was expected to underperform its required return by at least 5 percentage points over the succeeding 12 months (or 10 percentage points for a stock classified as Volatile*). Stocks between these bands were classified as Neutral.
*A stock was classified as volatile if its historical volatility had exceeded 40 per cent, if the stock had been listed for less than 12 months (unless it was in an industry or sector where volatility is low) or if the analyst expected significant volatility. However, stocks which we did not consider volatile may in fact also have behaved in such a way. Historical volatility was defined as the past month's average of the daily 365-day moving average volatilities. In order to avoid misleadingly frequent changes in rating, however, volatility had to move 2.5 percentage points past the 40 per cent benchmark in either direction for a stock's status to change.
Rating distribution for long-term investment opportunities
As of 29 October 2020, the distribution of all independent ratings published by HSBC is as follows:
Buy 57 per cent ( 33 per cent of these provided with Investment Banking Services )
Hold 34 per cent ( 31 per cent of these provided with Investment Banking Services )
Sell 9 per cent ( 26 per cent of these provided with Investment Banking Services )
For the purposes of the distribution above the following mapping structure is used during the transition from the previous to current rating models: under our previous model, Overweight = Buy, Neutral = Hold and Underweight = Sell; under our current model Buy = Buy, Hold = Hold and Reduce = Sell. For rating definitions under both models, please see “Stock ratings and basis for financial analysis” above.
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- This report is dated as at 02 November 2020.
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