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Focus on financial materiality
Sustainable Investing Research

Focus on financial materiality

Our SI research focuses on the link between sustainability and financial materiality. But what is financial materiality, exactly? Michael van der Meer, Head of SI Research explains how Robeco determines the financial relevance of the sustainability criteria that are incorporated into the investment process.

How do you define financial materiality, and why is this important for the Robeco methodology?

We consider any intangible factor that can have an impact on a company’s core business value – namely growth, profitability, capital efficiency and risk exposure – to be financially material. Factors such as a company’s ability, to innovate, attract and retain talent, to become Paris-Aligned or anticipate regulatory changes matter from an investor’s point of view because they have significant impacts on a company’s competitive position and long-term financial performance.

As an asset manager, we focus on identifying financially relevant sustainability factors. For this reason, we have created our sectorial materiality frameworks which help analysts focus on those factors that are most relevant to financial performance. This helps to ensure that we integrate financially material sustainability factors into our investment process in a structured manner. Because these factors are relatively under-researched by most investors, our integration of financially material sustainability factors in the investment process allows us to make unique and better-informed investment decisions for the long-term.

There has been much discussion about the materiality of sustainability. What makes your framework different?

Our financial materiality framework draws upon more than 20 years of experience in integrating sustainability into the investment process. What sets us apart is that our approach focuses on the intersection between sustainability and business performance. Specifically, we focus on identifying the most important intangible factors that relate to companies’ ability to create long-term value. For instance, lowering energy consumption in manufacturing processes results in significant cost-saving opportunities and has a direct impact on a company’s bottom line. This focus on the most financially relevant sustainability factors is essential, given our mission to create long-term attractive returns for our clients through sustainable investment strategies. However, the link between sustainability and business performance is also a priority for leading companies, which understand the pay-offs of their sustainability investments.
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So how do you determine which information is financially material?

We begin with a top-down industry and mega-trend analysis. For each of the 60 industries we assess, we ask ourselves which are the key sources of value creation for that industry, and which long-term trends are likely to have an impact on these industry drivers. Once we have identified material factors for each industry, we prioritize them according to their expected magnitude and the likelihood of their impact on growth, profitability, capital efficiency and risk. This results in a materiality matrix for each industry, which maps the relative importance of each material factor against each other and provides us with a visualization of the most important factors for each industry (see Figure 1).

Figure 1: Materiality Matrix 2020 - Automobiles OEMs

Source: Robeco

How is this information used in your company analysis?

Once we have identified and prioritized the material sustainability issues for each industry, our analysis shifts to the company level and evaluates how well company management is addressing each of these factors. Based on this analysis, we adjust our financial, growth and risk assumptions in order to obtain a better estimate of fair value, which not only takes into account short-term financial projections but also gives ample consideration to longer term sustainability factors.

Essentially, we determine which companies are most likely to remain competitive in changing business environments and are therefore best positioned to continue to create value in a sustainable way.

Although the materiality framework focuses on industry-specific criteria, have you identified any sustainability criteria or factors that are significant across all industries?

Yes. A variety of sustainability factors are relevant to companies across a wide range of industries. These include innovation management, human capital management, supply chain management, environmental management and corporate governance. The impact of products and services is also something we always look at, including how these enable, or detract from, achieving the Sustainable Development Goals (SDGs). But we tailor the questions in these criteria to the specific characteristics of each industry.
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How do you ensure that your research remain up to date?

Our SI Research Analysts work with our Quantitative Analysts to test the financial materiality of the factor we identify. Our quantitative research identifies which intangible factors have demonstrated the clearest correlations to past financial performance. In addition, our assumptions are continuously tested by the performance of our funds as we integrate sustainability into investment decisions.

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