When we talk about sustainable investment, we often hear about the « best in class » approach. But what exactly is it? Basically, it means choosing companies that perform best in their field, at an environmental, social, and governance (ESG) level. We don’t exclude an entire sector; instead, we look at who the top performer is in each category. It’s a way to encourage companies to improve, without having to forgo investing in certain sectors that can be important for the economy, by choosing the most responsible ones.
Key Takeaways
- The « best in class » approach selects the companies with the highest ESG performance within their own business sector.
- It differs from exclusion strategies by not banning entire sectors, but by favouring the best performers.
- This method encourages companies to continuously improve their ESG practices to remain competitive.
- It allows for the construction of diversified portfolios while taking into account the specific realities of each sector.
- It is often advised to combine the « best in class » approach with other methods, such as sector exclusions, to strengthen responsible impact.
Understanding the Best in Class Approach
Does responsible investing resonate with you? There are several ways to approach it, and one of them is the « best in class » approach. In essence, it means looking at which companies perform best in their field, in terms of environmental, social, and governance (ESG) criteria. The aim isn’t to exclude entire sectors, like oil or coal, but rather to identify the sustainability champions within each industry. It’s a way of saying: « Okay, this sector has challenges, but who is handling them best? »
Definition of the Best in Class Approach
The « best in class » approach is an investment strategy that selects companies with the highest ESG performance, but only within their own business sector. The idea is not to label a sector as inherently good or bad, but rather to recognise that ESG challenges and opportunities vary greatly from one industry to another. For example, reducing CO2 emissions is a different issue for a technology company than for a cement manufacturer. This method therefore aims to reward efforts and good practices, even in sectors considered more polluting. It focuses on relative leadership rather than absolute thresholds.
Distinction from Other Sustainable Investment Strategies
It’s useful to understand how « best in class » compares to other approaches. Unlike outright exclusion, which bans entire companies or sectors (such as those involved in weapons or tobacco), « best in class » can include companies from these sectors if they are the best in their category. Another approach, « best in universe, » selects the best ESG companies from all available companies, which can create significant sector biases, favouring renewable energy over other industries, for example. Finally, « best effort » focuses on a company’s continuous improvement of its ESG practices, even if it’s not yet the best in its sector.
Here’s a small table to clarify:
| Strategy | Main Selection Criterion | Inclusion of Controversial Sectors | Potential Sector Biases |
|---|---|---|---|
| Best in class | Best ESG performance within each sector | Possible (the top performers) | Low |
| Exclusion | Exclusion of companies/sectors deemed harmful | No | High |
| Best in universe | Best ESG performance across all sectors | Possible (if top performers) | High |
| Best effort | Improvement of ESG performance over time | Possible | Low |
Fundamental Principles of Selection
Selection according to the « best in class » approach is based on a few key principles. Firstly, ESG analysis is at the heart of the process. Companies are assessed on environmental (emissions, waste management), social (working conditions, community relations), and governance (executive compensation, shareholder rights) criteria. Secondly, this assessment is done comparatively, within each sector. A company in the automotive sector will be compared to other automotive companies, not to a pharmaceutical company. Finally, the objective is to encourage improvement. By selecting leaders, others are incentivised to do better to attract capital. It’s a bit like giving a medal to the top students in each class, hoping the others will work harder the following year. It’s important to note that even the best companies in a sector can have negative impacts; this is why this approach is often supplemented by other methods, such as engagement with companies or analysis of broker performance managing these funds.
The « best in class » approach is a pragmatic method that recognises the diversity of industrial challenges. It avoids overly simplistic judgments on entire sectors and prefers to identify and support companies making concrete efforts to improve their impact, regardless of their field of activity. This allows for the construction of diversified portfolios while integrating sustainability considerations.
Selection Criteria for a Best in Class Approach
The « best in class » approach relies on a rigorous selection of companies with the highest ESG performance, but within their own sector. The aim is not to exclude entire industries, but rather to identify the leaders in each field. The objective is to favour companies that achieve the best non-financial ratings in their business category. This acknowledges that environmental, social, and governance challenges vary considerably from one sector to another. For example, greenhouse gas emissions are not the same issue for a technology company as for a cement manufacturer.
Assessment of Sectoral ESG Performance
To apply the « best in class » approach, it is essential to assess the ESG performance of each company, taking its sector into account. This means comparing companies with each other, but only those operating in the same field. The goal is to identify companies that stand out for their exemplary practices, whether in terms of reducing their carbon footprint, managing their human resources, or the transparency of their governance.
Here are some key points to consider:
- Relevance of Indicators: Ensure that the ESG indicators used are relevant to the company’s business sector.
- Intra-sector Comparison: Selection is made by comparing companies within their own sector, not against the entire market.
- Potential for Improvement: Identify companies that, while already performing well, show a willingness to go further.
Analysis of Non-Financial Ratings
Non-financial ratings provided by specialised agencies are a valuable tool for this process. These ratings summarise the analysis of a company’s ESG performance. However, it is important to understand that these ratings can vary from one agency to another. Therefore, the methodology behind each rating must be analysed to ensure it aligns with the investor’s objectives. A good rating does not guarantee a complete absence of risk, but it generally indicates better management of sustainability issues. It is often advisable to cross-reference information from multiple sources to obtain a more comprehensive view. Analysing the best ESG ratings can help refine this selection.
Taking Sector-Specific Specificities into Account
One of the strengths of the « best in class » approach is its ability to integrate the specific realities of each sector. It is easier for some industries to reduce their environmental impact than for others. For example, a digital services company will have less difficulty achieving carbon neutrality than a mining company. The « best in class » approach recognises this difference and selects the best performer in each category, rather than applying a single standard to all. This allows for the construction of a diversified portfolio that reflects the complexity of the economic world while encouraging continuous improvement of practices within each industry.
Applying the « best in class » approach requires a detailed analysis of ESG performance, always within the specific context of each business sector. It is not simply a race for the best overall scores, but a process that recognises the unique challenges and opportunities of each industry to identify the most responsible and resilient companies.
Advantages of the Best in Class Approach
The « best in class » approach offers several interesting advantages for those looking to invest more responsibly. Firstly, it encourages companies to improve their environmental, social, and governance (ESG) performance. By selecting the best in each sector, it pushes others to improve so as not to be left behind. It’s a bit like a healthy competition where the goal is progress.
Encouragement for Continuous Improvement by Companies
This positive selection method encourages companies to look at what their top-performing competitors are doing in terms of ESG. If a company sees that its peers in the same sector are achieving better ratings, it will be more inclined to invest in more sustainable practices. This creates a dynamic of constant improvement, as no one wants to be at the bottom of the class. We thus observe a gradual evolution of standards within industries. It’s a pragmatic way to encourage change without necessarily excluding entire segments of the economy.
Construction of Diversified and Balanced Portfolios
One of the major strengths of the « best in class » approach is its ability to build well-balanced portfolios. Unlike strategies that exclude entire sectors, this one allows for the inclusion of companies from all fields. The idea is to choose the best performer in each category, whether it’s technology, energy, or consumer goods. This helps maintain good diversification, which is generally beneficial for risk reduction. Thus, a portfolio can be constructed that reflects the global economy while integrating sustainability criteria. It’s a way to build a diversified and balanced portfolio [318b].
Flexibility in Taking Sectoral Constraints into Account
Each business sector has its own challenges and constraints, particularly regarding the environment. For example, it is more complex for a cement manufacturer to reduce its CO2 emissions than for a software company. The « best in class » approach recognises this reality. It allows for the selection of the best-performing companies within their own sector, taking these specificities into account. This makes the approach more realistic and less dogmatic. The same is not expected of a company in the automotive sector as from a company in the healthcare sector. This flexibility is a major advantage for responsible asset management [8b21].
The « best in class » approach allows for the selection of the most virtuous companies within each sector, thereby recognising the inherent differences in economic activities while stimulating continuous improvement in ESG performance.
Limitations and Complements to the Best in Class Approach
Risk of Investing in Controversial Sectors
One of the main criticisms of the best in class approach is that it does not exclude problematic sectors. Even by selecting the highest-rated companies on ESG criteria in each industry, it is possible to invest in sectors such as the oil industry, tobacco, or armaments. In simple terms: being the « top student » in a less virtuous class remains questionable for many ethically-minded investors.
It sometimes happens that portfolios labelled « best in class » include the most responsible portion of heavily polluting or controversial sectors, leading some to doubt their alignment with sustainable development values.
Need to Combine with Other Selection Methods
The best in class selection often benefits from being supplemented. Here are some commonly followed avenues:
- Sector exclusions: completely removing certain sectors (weapons, tobacco, coal…)
- Normative exclusions: banning companies that violate international norms (human rights, UN standards…)
- Best effort approaches: prioritising continuous improvement, not just the current level
- Shareholder engagement: influencing company strategy through voting or dialogue
An example of this enrichment logic is the application of the SRI label, which requires going beyond a simple best in class approach to guarantee the social quality of investments (the SRI label thus promotes responsible practice).
Importance of ESG Rating Analysis
Non-financial performance relies on ESG ratings, but they are not always consistent between rating agencies. Issues encountered:
- Divergences in methodology between agencies
- Sometimes slow updating of scores
- Incomplete or unverified data
- Risk of greenwashing in the absence of checks
| Problem | Potential Consequence |
|---|---|
| Divergence of ESG scores | Difficulty of comparison |
| Unharmonised data | Risk of biased investments |
| Lack of transparency | Less trust from savers |
Rigorous analysis of ratings and ESG criteria therefore remains a key point of vigilance for the selection and monitoring of SRI portfolios.
Implementing the Best in Class Approach
Implementing a « best in class » investment strategy requires a structured approach. It’s not just about looking at ESG scores, but understanding how they apply concretely in each sector. It’s a bit like choosing the best fruits from each basket, without ignoring that some baskets are naturally more fragile than others.
Defining the Responsible Investment Strategy
The first step is to clearly define your fund’s philosophy. What does responsible investment mean to you? For a « best in class » approach, this involves committing to selecting the companies with the highest ESG performance within their own sector. This means that even in industries traditionally seen as less sustainable, we seek to invest in the leaders of improvement. It is also necessary to decide whether this approach will be used alone or combined with other methods, such as targeted sector exclusions to avoid the most problematic activities.
Analysis of ESG Criteria and Company Selection
Once the strategy is defined, it’s time for analysis. The environmental, social, and governance (ESG) performance of each company must be closely examined. For the environmental aspect, for example, one can look at how a company manages its greenhouse gas emissions, its water consumption, or its waste. The idea is to compare companies within their sector. A company in the automotive sector that reduces its CO2 emissions will be ranked higher than another that does not make this effort, even if the sector as a whole has a greater impact than, say, the software sector. It is important to look at available ESG ratings, but also to understand what they hide. Raw data on emissions management is often more telling than simple scores.
Portfolio Construction and Monitoring
After identifying the « top students » in each sector, the portfolio needs to be constructed. This involves selecting securities while considering both ESG criteria and traditional financial objectives. The goal is to have a diversified portfolio that reflects the chosen « best in class » strategy. For example, one might decide to allocate a certain percentage to each sector, always selecting the highest-rated companies in that sector. It is also possible to focus on specific markets, such as the Swiss market for example, applying the same logic.
The work doesn’t stop there. Regular monitoring is essential. It is necessary to ensure that companies continue to improve their ESG performance and that the portfolio remains aligned with the initial strategy. Regular reports on non-financial performance and the fund’s impact are necessary for transparency. It is a continuous process of evaluation and adjustment.
Conclusion on the ‘Best in Class’ Approach
Ultimately, the « best in class » approach offers a pragmatic way to integrate ESG criteria into investment decisions. It allows for the recognition of companies’ efforts within their own sector, even in areas traditionally considered less green. However, as we have seen, this method alone can have its limitations. For a truly responsible investment strategy aligned with strong convictions, it is often wise to supplement it. Considering combining « best in class » with other methods, such as targeted exclusions, can help build a portfolio that not only seeks out the top performers but also avoids the most problematic practices. It’s a way to navigate the world of sustainable investment, seeking a balance between performance and positive impact.
Frequently Asked Questions (FAQ)
What is the best in class approach?
The best in class approach is a way of choosing companies to invest in by looking at those that are the best on ESG (environmental, social, governance) criteria within their sector. We don’t reject an entire sector, but we keep the companies that make the most effort to be responsible.
What is the difference between best in class and exclusion?
The exclusion method directly removes certain sectors or companies deemed bad for the planet or society, such as weapons or coal. Best in class, on the other hand, keeps the top performers in each sector, even in difficult sectors.
Why choose the best in class approach?
This method encourages all companies to improve, even in sectors that pollute heavily. It also helps create a varied and balanced portfolio, as entire sectors are not removed.
What are the disadvantages of the best in class approach?
One weakness is that you can still invest in companies from controversial sectors, like oil, if they are the least bad. For this reason, some prefer to combine this approach with other methods, such as exclusion.
How are ESG criteria chosen for best in class?
ESG criteria are adapted to each sector. For example, a construction company and a services company will not be judged in the same way, as their impacts are different. Non-financial ratings, reports, and the company’s efforts are considered.
Can the best in class approach be mixed with other methods?
Yes, it is even recommended. Many fund managers add exclusions or other criteria to better respect investors’ values and avoid certain sectors, even if a company is the best in that sector.
