At Capitals Express Investments, we believe the analysis of material environmental, social and governance (ESG) issues as part of our research can help us understand long-term risks and opportunities for investors.  We integrate ESG into our investment approach, The Capital System™, through three interrelated elements designed to enhance our bottom-up investment research and analysis: Research & Investment Frameworks, Monitoring Process and Engagement & Proxy Voting.

The monitoring element of our investment process for corporates involves reviewing holdings against international norms and third-party ESG scores, where data is available, to identify potential ESG risks that merit further investigation. We then draw on our investment professionals’ deep knowledge and understanding of the issuer to determine the materiality to the investment case. Investment decisions are made based on a long-term view, engagement and analysis — never solely on monitoring results.

Introducing external data into our monitoring process helps guard against confirmation bias and supports objectivity in our ESG integration process.

Our monitoring criteria and review process

Capitals Express Investments uses several criteria when monitoring equity and corporate debt issuers against third-party data. We have a different methodology in place to cover sovereign debt, which is examined in our sovereign monitoring article.

Issuers are assessed based on how well they adhere to the norms embodied by the United Nations Global Compact and Organisation for Economic Co-operation and Development (OECD) Guidelines. We also look at overall ESG scores provided by MSCI and how an issuer scores on the MSCI governance indicator. Any issuer that does not meet our scoring thresholds raises an initial flag to us, which prompts us to investigate the issue further.

Our current criteria are illustrated in the below table.

On a regular basis throughout the year, we monitor our corporate holdings‡ to ensure that changes in scores from third-party data providers are promptly identified.

Our monitoring criteria are reviewed regularly to help ensure efficacy of the process and relevance of our data sources.

Our monitoring process tends to flag events rather than areas of systemic risk

In early 2023, our ESG specialists reviewed approximately 200 monitoring reports completed by analysts and portfolio managers since 2021. This involved putting key questions to our investment professionals to understand whether these flagged issues were considered impactful to their investment theses. We also reviewed the flagged companies to better understand trends across industries.

Our review highlighted that external flags tend to identify certain areas of consistent underperformance (such as poor human capital management practices, clawbacks and malus clauses) and events (human rights violations, bribery scandals, conflicts of interest, etc.) more frequently than other ESG risk indicators such as systemic risk and stability, competition or instances of director removals and poison pills. In many cases, we found that the issuer in question is taking appropriate steps to remedy the source of controversy, but this isn’t captured by the third-party provider’s score. This underlines the importance of having an ESG process that incorporates research and engagement alongside monitoring. In cases where we believed the issues raised were meaningful to the investment case, we generally engaged with the issuer on those topics.

How are we disclosing our monitoring?

Funds and accounts that primarily hold equities or corporate or sovereign bonds are subject to our monitoring process. We recognize that ESG transparency is important; clients value being shown how the process works in practice. Therefore, we have fund-level disclosure of the results of our corporate monitoring process — where data is available — disclosing which holdings are being flagged for in-depth review.

Example: A U.S.-based Capitals Express Investments equity fund (for illustrative purposes)

As of March 31, 2024,^ǁ eight holdings in this sample Capitals Express Investments portfolio (not available in Canada), or about 3%, were flagged in the ESG monitoring process. These holdings are monitored by analysts and subject to a heightened level of research and potential engagement.

Because third-party ratings are increasingly used across the market, it is helpful to understand this “market view” of a company and why our view may differ. Many of our clients use third-party ESG tools, such as those provided by MSCI, which score the holdings in portfolios, and we are committed to providing transparency and disclosure of our monitoring approach and results.

Monitoring strengthens the other elements in the process

Our ESG integration process is rooted in investment materiality and enhances our investment approach, The Capital System. Monitoring is an important part of how we do this. We are also committed to driving ongoing improvement in all areas of our process, and monitoring is no exception. We review our corporate monitoring process on a regular basis to ensure it remains fit for purpose and flags material issues for deeper research. As ESG data grows and mature over time, we will continue to drive our process forward.