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Many investors want to factor environmental, social, and governance (ESG) considerations into their investment decisions. ESG scores started as a well-intentioned means to simplify this process.
However, the inconsistency across ESG ratings providers has had the opposite effect. Investors are now struggling to unpack the providers’ data and methodologies to arrive at comparisons that actually make sense.
Half of global investors surveyed in Capital Group’s ESG Global Study 2022 responded that “Overcoming the lack of consistency in ESG Scores” is the number one challenge to using ESG data for investing purposes.
ESG scoring methodologies don’t align
Like a credit score, ESG scores are used to quickly compare companies across sectors, regions, and large portfolios. They are established by influential third-party ratings agencies who have done the heavy lifting of aggregating huge amounts of data. Unlike credit scores, ESG scores differ significantly from one ESG score provider to another.
This is because the main ESG ratings providers – MSCI, Sustainalytics, Refinitiv, Bloomberg, Thomson Reuters, and RobecoSAM – use custom methods to assign ESG scores to different entities.
According to one study, differences across six major ESG score providers mostly derived from contrasting measurements (56%), scope (36%), and weighting (6%). Additional qualitative variance across different scoring providers can also impact scores:
- ESG frameworks: Scoring may use material topic indicators from standards setting organizations such as GRI, SASB, ISO standards. ESG Scores disagree on which to use.
- Including legal or reputational controversies: Refinitiv breaks away controversies into a separate “ESGC” score. Others do not.
- ESG materiality differences: MSCI and Sustainalytics explicitly identify the financial materiality of an ESG risk category as a key consideration. Others may view materiality through the lens of stakeholders’ priorities or positive and negative impacts.
- Time horizon for risks: Some providers consider forward-looking risks and opportunities, while others limit their analysis to historical data.
- Score format: MSCI uses letters, while Sustainalytics uses a numbered scoring system.
While this list is not exhaustive, it shows why it’s difficult to compare scores from one provider to another. For investors wishing to invest in a way that drives a specific impact, scores may lack necessary detail. Even worse, they might embed qualitative judgments that don’t align with the investors’ own strategy or take on ESG.
YourStake addresses this issue with our No Score ESG approach. One of our reports is the Metaphor report, which can be used to showcase investment responsibility in understandable terms like “15 fewer asthma attacks” or “34 fewer cars driven” for a given level of investment. Fund advisors can share these reports with their clients, who then gain a tangible sense of the impact of their investments.
How ESG Scores Handle Raw ESG data
ESG scores condense thousands of data points into a set of aggregate entity-level scores. The raw ESG data comes from a variety of sources. These include independent research, news reports, governmental data, and corporate ESG reports.
While raw ESG data is difficult to work with due to its complexity, ESG scores can have the opposite effect by oversimplifying the data. For this reason, companies need tools and teams who can help them access useful insights from the raw data.
In the YourStake platform, we retain the information-rich ESG data, but provide it in a format that makes comparing funds, securities, and even portfolios easier. Our raw data sources include publicly available data sets from external sources.
We generally avoid relying on the “messy” data reported voluntarily from companies, which is hard to compare. Gaps in ESG data can appear where some companies report on certain topics but others do not. Even for topics like carbon emissions, which have become more standardized, companies can use different metrics and targets.
With data that provides more transparency on fund and security performance for the themes covered by ESG, fund advisers can play a more active role in creating ESG portfolios.
Is active management the answer?
Many fund advisers combine multiple sources of ESG data along with their own ESG research for a variety of purposes. Some asset managers customize ESG considerations within bespoke portfolios for particular investors’ aims. Others aim to target stronger links between ESG risks and financial performance to land at “true ESG value.”
Researchers are also expanding the range of ways to use ESG data:
- Active ESG share: University of Notre Dame researchers created an alternative metric to evaluate how actively fund portfolio managers use ESG information. Funds showing a higher engagement with ESG information tended to outperform those that simply relied on third-party ESG scores.
- Combining scores: Researchers at MIT found that combining ESG scores from multiple providers led to higher returns than simply relying on the scores of one provider.
YourStake’s Multi-vendor Proposition allows firms to integrate our platform’s transparent data analytics into their existing collections of third-party data and independent research. This cuts down the research time and brings more flexibility into ESG portfolio management approaches.
Ultimately, the aim is to enable investors to drive the ESG investing process more actively with the help of their financial adviser. We help asset managers sync with their clients’ core investing values throughout portfolio creation.
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