Edinburgh was host to the Ethical Finance Conference last week where Nicola Sturgeon, Craig Bonthron and other famous names presented. One of the panels discussed ESG data issues and the misconceptions that the market has with ESG rating agencies. I found one point particularly interesting, around ESG rating correlations.

It’s true that we have pointed out rating agency limitations before and summed it all up in a previous blog (no consideration of product impact, market cap and regional bias, incomplete data and backwards looking). We often refer to examples of highly-rated tobacco companies making the cut in ESG funds, where investors hope their capital is promoting a better/healthier/more sustainable world.

But to buck the trend, I want to point out one criticism that I feel they don’t deserve and it revolves around the following chart…

This shows the correlation of ESG scores between two major providers – or the lack of. This has led some to ridicule ESG data when held up alongside the likes of Fitch, S&P and Moody’s highly correlated credit ratings. The argument being that ESG investing should not be trusted until the industry matures and ratings converge. Otherwise, how can we possibly follow what one issuer says versus another?

Our view? Quite simply, we shouldn’t. This would grossly oversimplify ESG metrics and what they can actually tell us.

Take GHG emissions for example, this should be an objective measure that is easily calculated allowing rating agencies to attach AAA to low emitters and CCC to high emitters. The data would have to be standardised by let’s say, tonne Co2 per $1m dollar revenue. But under this method comparatively would a tobacco company be considered a less risky investment to an EV manufacturer? Both face completely different environmental challenges.

Issuer_Name tCo2/usd million sales
Philip Morris International 21.90
TESLA, INC. 40.00

Source: MSCI data

Then there are the issues that really should not be measured against one another. Labour management is often assessed, which is essentially the culture of an organisation. But what is ‘good’ culture?  I’ll quote Investopedia’s definition; “culture is implied, not expressly defined, and develops organically over time from the cumulative traits of the people the company hires.” Ermm yes, it’s unique to each company and whilst metrics such as turnover, pay and diversity can help to understand it, a subjective assessment is still required. What might be deemed ‘good’ culture for a tech company in the US, might not be the same if applied to an industrial in Taiwan.

Ultimately, these scores should be treated like an opinion. In much the same way that three different brokers will have three separate price targets for a stock, maybe even spread across buy/sell/hold, underpinned by different methodologies and assumptions.

We should not expect highly correlated ESG scores and instead each one should be evaluated on its own merits.  Convergence of ESG ratings is unlikely and not what the industry should be aiming for.

About the author

Euan Ker is a Sustainable Investment Analyst. He is responsible for analysing and monitoring environmental, social and governance factors within the Global Sustainable Equity Strategy. Euan joined us in 2014 as an investment implementation analyst with responsibility for implementing macro investment decisions across a number of fund-of-fund mandates, totaling some £13 billion under management. Prior to moving to the ESG Research team in 2018 his responsibilities also included asset class, regional and currency hedging overlays through derivatives. Euan has a 1st Class Honours degree in Management with Economics from Robert Gordon University. He has the IMC professional qualification and has 5 years’ industry experience.* *As at 30 April 2019.

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