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Rashila Kerai

Rashila Kerai

DJSI: Detecting sector-specific, financial materiality

March 2016 User View by Rashila Kerai, Sustainability Analyst RobecoSAM, Switzerland

AT RobecoSAM we believe that you can’t take a long-term view of a company without thinking about sustainability. We’re an asset manager focused solely on integrating sustainability into the investment process. This is grounded in the belief that we can provide better informed investment decisions through the incorporation of sustainability information into financial analysis.

From the very beginning, our research has focused on how sustainability performance can identify companies that will succeed over the long-term. Integrating sustainability into investment analyses is the basis for gaining value added insights into the longer-term quality, positioning and competitiveness of firms. Through this process, we are able to drive positive change by allocating capital to the most sustainable companies and providing concrete insights to companies on the positive benefits of sustainability initiatives on their bottom line.

Focus on financially material factors

While there are several views of materiality, we define materiality of sustainability from the investor’s perspective: “sustainability factors that can have a present or future impact on companies’ value drivers, competitive position, and therefore on long-term shareholder value creation”. Impacts on company value drivers include growth, profitability and risk.

For each factor, we determine the extent it could have an impact on a company’s financial performance and the time frame of this occurring. This analysis is conducted on an industry basis resulting in an industry specific materiality matrix. The matrix shows the relative importance of the issues which helps us focus our analysis on the more important topics. Below is an example of the materiality matrix for the chemicals industry.

Materiality Matrix for the Chemicals Industry

Source: RobecoSAM

     Source: RobecoSAM

The most significant issues and success factors in this industry include Environmental Management, Product Stewardship, Innovation Management, Occupational Health and Safety, Customer Relationship Management, Corporate Governance, and Human Capital Management. Impacts on the business value drivers include:

  • Growth. Innovation and product stewardship responding to changes in markets, customer demands, or competitive positioning.
  • Profitability. Management of costs related to emissions, regulatory compliance, safety, or talent attraction and retention.
  • Risk. Exposure due to corporate governance, business conduct, customer complaints, excessive safety incidences, or concerns from external stakeholders.

Therefore, these factors are also important for integrating sustainability into the investment case and identifying high quality companies that are attractive over the long term.

Materiality and the DJSI assessment

The materiality matrix also guides our annual revisions to the assessment for the Dow Jones Sustainability Index (DJSI) to capture relevant and emerging issues. The assessment consists of 59 questionnaires, one per industry, and covers a broad range of environmental, social, and governance topics. Some topics are general and apply to all industries, for example, corporate governance. However, more than half of the criteria are industry specific. For example, product stewardship is very relevant to chemical companies, but is less relevant to service companies.

We are working to streamline the questionnaire, to reduce where it makes sense, while at the same time making sure we continue to capture new and emerging topics. The review process is guided by three main considerations:

  1. Review of the current questionnaire in the context of the updated materiality framework. Important issues are the ones to keep, less important issues could be candidates for deletion.
  2. Relevance for investment decisions: Is there alignment with our materiality frameworks? Does it provide us useful and differentiating information for integrating sustainability into company valuations?
  3. Relevance for the companies: We review the questionnaire responses where companies tell us what they consider important issues. These are the criteria to keep. In 2015, we also conducted a separate survey to ask what topics are less important that companies would recommend for removal or topics that are missing and should be added. We use this feedback to calibrate our views.

Combining these perspectives helps us identify areas where questions can be removed, added, or modified. Changes that can be immediately implemented are reflected in the next questionnaire. This process also helps identify criteria for further research, analysis and consultation which would lead to future improvement.

In the assessment, we evaluate how companies explain their materiality analysis in a way that is relevant to investors. We are interested in knowing what companies consider the most important material issues, and for each issue why it is material, how it will impact the business, and what is the strategy to respond to the issue.

It’s important to highlight that the prioritized issues do not have to be just about risk reduction. It’s also about opportunities. Given the long term trends in the industry, how are companies positioning themselves to grow and be profitable as well as reducing risk exposure? For example, most chemical companies have targets to reduce their direct environmental emissions. Leading companies see sustainability as a driver for growth and are able to increase their revenues from products that deliver same or better functional features with improved sustainability performance.

Materiality informs both our investment analysis and the information we ask

The annual assessment cycle provides us a very useful feedback loop: The questionnaires help us understand how companies are performing on material sustainability topics. This helps us with the needed information for investment decisions, which in turn helps us update our views on the industry and companies, which in turn guides our questionnaire updates.

We will continue to encourage companies to understand, manage, and report on new and emerging sustainability topics. Ultimately, this equally benefits the participants in our questionnaire by providing strategic guidance related to sustainability, and investors through better informed investment decisions.

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