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ESG

Ratings vary, but work as good starting point

Jessica Ground sees overlap on governance scores, but not on environmental and social issues.

While some in the money management industry level criticism at the providers of environmental, social and governance ratings for producing differing results, educating investors on these scores may be all that's needed.

"It is important for investors to understand how ESG data is used, the methodology and the metrics," said Amandeep Shihn, head of emerging markets equity and sustainable investment manager research at Willis Towers Watson PLC in London. "There can be variations when looking at companies across industries globally or across industries regionally — both approaches are different, but can both be correct."

Jessica Ground, London-based global head of stewardship at Schroders PLC, highlighted that there are differences among the providers' ratings often for the same companies. "There seems to be a reasonable amount of overlap when it comes to governance scores, but when it comes to other things — particularly environmental and social issues — then there seems to be a bit more of a difference."

There are also regional biases in some cases, with European companies tending to disclose more on carbon, for example; and also a skew toward large-cap companies with the resources to fulfill the questionnaires and surveys that providers use in some cases to gather information for ratings. That means index-tracking strategies based on these ratings tend to also have these skews and may introduce unintended risks, such as unexpected exposure to individual sectors.

Ovidiu Patrascu, a research analyst on the sustainability team at Schroders, added that the main issue with ESG ratings use in index-based strategies "is the fact that they capture policy disclosures, not necessarily sustainability characteristics. The metrics don't really capture anything relevant for climate change risk management."

However, he added it is "unrealistic to expect these products can achieve those" findings.

But those differences can be overcome by using ratings as a starting point, as many managers — including Schroders — do.

And what is important is that investors understand why those differences occur.

"You may not have the same view from different vendors on each company, and that's OK, but you need to understand why each approach leads to the answer. It's easy to see asset managers following the path of (large institutions) where they are consumers of multiple sources of third-party data but recombine them in a way that is consistent with how they assess companies and based on issues they see as being material. Large institutions are using third-party data to create and develop their own ESG scores. (In that case it is important for investors) to understand how those managers think about sustainability issues in general, how they look at which data providers provide their information on those subsignals and why they pick those particular vendors for those particular subsignals," Mr. Shihn said.

Lauren Smart, London-based managing director, global head of financial institutions business at Trucost Ltd., an arm of S&P Global Inc., recognized that ESG ratings receive criticism for not always being the same for the same firms. "To my mind, that is not a problem at all — when you look at sell-side ratings you want differences of opinion, (you want) to read an analyst's opinion. It is the same with this — data points are weighted and rolled up into a rating, and you can deconstruct and look at the underlying data points … Different people will get value from different aspects."

"It is not because (ratings are) inherently flawed that they say different things," Ms. Smart said. "It's because there's opinion in there too."