Divergent ESG Ratings

Abstract

Responsible investors require data to underpin their stock and sector selections. Regardless of the rating agency, bond ratings for a particular issuer are broadly similar. This is not the case for ESG ratings. Companies with a high score from one rater often receive a middling or low score from another rater. This article examines the extent of, and reasons for, disagreement among the leading suppliers of ESG ratings. The weightings given to each pillar of an ESG rating also vary across agencies. Many asset managers contend that ESG ratings can help investors to select assets with superior financial prospects, and the authors therefore review the investment performance of portfolios and of indexes screened for their ESG credentials. In the authors’ opinion, ESG ratings, used in isolation, are unlikely to make a material contribution to portfolio returns.

TOPICS: Equity portfolio management, ESG investing, foundations and endowments, performance measurement, wealth management

Key Findings

• • Data is essential for making investment decisions, and most institutions rely wholly or partly on external providers of ESG data. However, there is minimal correlation between ESG ratings from alternative agencies.

• • This article explains why different raters’ appraisals diverge. The article also examines whether ESG is associated with subsequent fund or index outperformance.

• • Over the longest available period, ESG indexes did not outperform the “parent” index from which they are derived. Equally, however, for the two indexes that most closely represent what ESG investors actually do (FTSE4GOOD and MSCI-ESG) there is no evidence of underperformance.