Comparing ESG Ratings
Today’s businesses increasingly want to be seen as performing well on ESG (environmental, social, and governance) measures. Changes in attitudes in the investing community mean that fewer funds are willing to invest in companies that, say, massively pollute their environment or treat their workers poorly.
Investors and progressive businesses, however, have a problem: how to measure ESG performance. It’s a slippery, qualitative concept that needs to be measured more rigorously. Unfortunately, many “ethical” investors and socially-orientated business leaders currently go with their intuition instead of using robust performance metrics to prove their ESG credentials.
What Is An ESG Rating?
A group of agencies, however, has noted this hole in the market and set about trying to do something about it. ESG performance ratings tell company bosses how well their companies are doing in this regard.
Who measures ESG? Let’s take a look at some of them now.
MSCI is a significant player in the investing world, offering money managers and retail customers the opportunity to purchase a wide range of equity- and bond-related assets, particularly ETFs.
Since the emergence of ESG considerations, MSCI has been looking for ways to make company performance more transparent in this regard. The agency uses a combination of 200 analysts and artificial intelligence to calculate the ESG performance of companies and then assign a rating. Currently, businesses rank on a scale from C to AAA.
It’s not a dumb ranking system either. MSCI uses a broad cross-section of data from both voluntary company disclosures and alternative data sources to generate a complete ESG picture.
Sustainalytics’ ratings work on a similar principle to MSCI’s, helping investors choose portfolios that match their ESG goals.
The agency, however, does things differently from some of the others. First, it starts by measuring the exposure of each company to ESG risks at the sub-industry level. It then looks at management dimensions to calculate how well the organization is mitigating its exposure, differentiating between manageable and unmanageable risks. It then evaluates the company’s policies in relation to its manageable risks, identifying where it has been effective and where it could lead to higher risks. The final rating between 0 and 100 then compares the total unmanageable risk to the degree to which the enterprise accommodates its manageable risks.
Sustainalytics makes it easy for investments to determine whether they should invest in a particular company or not. Each report identifies the level of risk of the company (whether low, medium, high, or severe) and compares its risk to industry peers. It then goes on to break down the different risks that the company faces, depending on agreed-upon sub-industry standards. For instance, the report might report the threat from carbon dioxide, bioethics, or human capital.
It then reports the absolute magnitude of the risk of the company with the total score delivered at the top. Sustainalytics now covers more than 11,000 companies and uses more than 40 industry-specific indicators to keep investors informed.
The Morningstar Sustainability Rating
The purpose of the Morningstar Sustainability Rating is similar to those of the agencies above: to provide investors and shareholders with quantitative information about the environmental, social and governance performance of various companies, compared to their peers.
The Morningstar Sustainability Rating system has been running since 2016 and now features in more than 50,000 funds. What’s interesting about the agency’s approach is that it uses the same scale across all economic sectors, allowing investors to make direct comparisons of one company to another, even if they occupy different areas of the economy.
For instance, oil and gas companies automatically have their ESG scores bumped up because of their carbon dioxide emissions. The agency, for example, gives Royal Dutch Shell a risk score of 33.7 because of its impact on the environment, compared to Microsoft’s relatively low 14.1, despite similar governance. Unlike some of the relative scores of other ESG metrics, the Morningstar approach accepts the inherent difference between industries. In short, it doesn’t matter how exceptional the “S” and “G” components are at an oil and gas company, it can never overcome the core effect of its operations on the planet.
All of the ESG rating schemes discussed here attempt to quantify something that had once been qualitative. With them, investors can objectively measure the sustainability of their portfolios relative to ESG criteria, instead of having to guess.
Business leaders need to be aware, though, that the rating systems differ markedly. Some offer absolute measurements of company risk, while others are relative.