Our primary reason for choosing screening and integration strategies in relation to ESG factors is that it complements our process and is not seen as an add on, but simply part of our every day process.
Solaris utilises material ESG factors in the same way that our analysts will utilise any material information relevant to a company's operations and therefore valuation.
In the same way that certain factors may render a stock non-investment grade, so too may ESG factors. In some instances we may screen stocks from our investable universe at our initial risk screening stage due to ESG impacts.
As we treat ESG factors as additional pieces of a company's profile, it follows that our analysts also consider ESG factors within our Qualitative assessment stage.
The evaluation of ESG issues is undertaken by the analyst responsible for the company. Analyst empowerment is an important feature of the Solaris investment process. Every company in the S&P/ASX200 is covered by a dedicated analyst and the decision to include or exclude that company in Solaris’ investment portfolios is predominantly the decision of that analyst. ESG evaluation forms part of the analysts’ overall assessment of that company. It is important to emphasize that this is not a new aspect of the analyst role. All current analysts have, in their past, had to make ESG evaluations. Solaris also employ an ESG Analyst who provides the analysts with additional information and research capacity where required.
ESG factors are considered at two stages within the Solaris Investment process:
- The initial risk screening stage where Liquidity, Financial, Geo-political, ESG and Litigation risks are assessed. Stocks that fail to pass any of these risk screens are considered non-investment grade and are not included in the Solaris universe.
- Qualitative assessment stage – The criteria examined by our analysts include:
- Business Model
- ESG factors
- Balance Sheet
- Cash Flow profile
- Trend in Return on Equity
The conclusions drawn by analysts from their qualitative assessment feeds into the appropriate rating applied to each company’s valuation. For the most commonly used valuation technique: DCF, this involves adjusting the beta to incorporate positive or negative factors discovered in the qualitative assessment. Accordingly, conclusions drawn from the assessment of a company’s ESG activities may affect that company’s rating and its valuation.
The main portfolio construction technique that Solaris use is based on expected return. Simply put, if a company has a high expected return that company will, prima facie, be included in the portfolio and equally a low expected return (or negative excess return) will see a company not held in the Solaris portfolios. It follows, therefore, that a poor ESG evaluation may result in the company’s valuation being marked down and reducing the company’s chances of being included in a Solaris portfolio. Conversely a positive ESG evaluation may result in the company’s valuation being upgraded and increase its chances of being included in the portfolio.
In addition Solaris manages three negatively screened portfolios under Individual Mandate agreements (IMAs) where the clients require certain stocks that derive a percentage of their revenues from certain activities to be excluded from consideration for investment. In practicality, these exclusions are considered in the Initial Risk Screening stage and the stocks are excluded from the client's investable universe.