ESG Risk refers to the risk of factors attributable to environmental, social and governance issues that have an impact on the performances of a mutual fund’s securities.
E Risk (where “E” stands for “environmental”) is a variant of ESG Risk and calculates the risk arising from factors primarily attributable to environmental issues that have an impact on the performances of a mutual fund’s securities.
Sustainability objective of Etica’s funds
ESG Risk (and E Risk in the case of Etica Impatto Clima) is the indicator that best summarizes the sustainability objective pursued by the funds managed by Etica and classified as products as defined in Article 9 of EU Regulation 2019/2088.
The metric, calculated on the basis of the sustainability scores prepared by Etica Funds’ Analysis and Research Area using the proprietary ESG EticApproach®️ method, provides an overview of the sustainability of issuers and, in the aggregate, of portfolios. According to Article 9 of SFDR, the sustainability objective translates for funds into setting a pre-determined percent limit on ESG Risk (or E Risk) lower than the implicit theoretical maximum level in the model used to estimate sustainability risk.
Why calculate investment risk?
One of the main objectives of investing is of course obtaining a return. However, there are no returns without risk. Accordingly, it is necessary to monitor the risk variables that could give rise to a negative impact on investment performance. Some examples are: the risk of changes in interest rate risk and foreign exchange risk.
Recent history has proved that risk – and thus potential loss of return – may also result from factors attributable to environmental, social and governance (ESG) factors. And yet, until recently, there were no satisfactory measurements for assessing it. Etica Funds has solved this problem.
Etica Funds’ Risk management created a proprietary metric of a statistical, predictive nature capable of estimating “ESG Risk” beforehand.
How does it work?
Each security in the portfolio is assigned an ESG score: higher for the securities of more virtuous companies and countries, lower for those less attentive to these issues. All this makes it possible to organise the securities into classes by ESG Risk (or E Risk). Given this distribution, ESG Risk (or E Risk) is lower the more virtuous securities are in environmental, social and governance terms (or in environmental terms for E risk) are concentrated in classes with the highest scores.
The metric provides also an overview of the sustainability objective pursued by the funds managed by Etica, which for each fund classified according to Article 9 of SFDR consists of a pre-determined percent limit on ESG Risk (or E Risk) lower than the implicit theoretical maximum level in the model used to estimate sustainability risk.
Integration of ESG risk in Etica Funds’ investment approach
This metric contributes to the formulation of the investible universe: during the issuer selection phase, in addition to negative screening criteria, the award of a sustainability score and the application of the best-in-class approach, ESG Risk (or E Risk) is also assessed to create investible universes with sustainability risks below the Company’s pre-determined thresholds (implicit theoretical maximum level) that are not discontinuous over time, in protection and the exclusive interest of subscribers.
Through this model, Etica Funds also assesses the impacts of sustainability risk on the returns of its financial products by calculating, for the various portfolios, risk-adjusted performances in ESG terms over time.
ESG risk: why use it?
The ESG risk metric formulated by Etica Funds paves the way to an innovative, rigorous approach due in part to the fact that it has been proved that there is a strong statistical correlation with portfolio traditional financial risk (Non-diversified VaR).
In conclusion, it may be stated that taking an approach to investment that also considers non-financial issues is rewarding in the long term.
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