Investor Strategy: How ESG ratings providers let the side down

16 February 2020

An often-expressed criticism of the ESG investing space, mainly by institutional investors, is the lack of robust benchmarks and/or ratings from independent bodies. ESG investing is complex. A new study by Research Affiliates indicates just how much work the industry needs to do to improve accountability.

The study is called: “What a Difference an ESG Ratings Provider Makes”. It analyses the work of two major ESG ratings firms in the US, against a backdrop of other ESG information providers. Their differences are significant and worrying. The study identified and looked at about 70 ESG ratings providers. The key points are:

• ESG ratings vary markedly by ESG ratings provider because each provider has a unique methodology for assigning company-specific ratings. Investors, therefore, must ensure the approach taken by the ratings provider they rely on is consistent with their ESG preferences or they risk constructing portfolios that do not align with their ESG views.
• ESG portfolios constructed using the ratings of two well-known ESG ratings providers yield large performance dispersion and low correlation of returns. The differences are even greater at the individual ratings level for environmental, social, and governance scores.
• The differences in how ratings providers calculate ESG scores can result in the same company being ranked quite highly by one provider and quite poorly by another. Understanding which metrics are evaluated and how they are assessed is essential to investors selecting stocks that meet the ESG criteria they care about.

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