"ESG Ratings and Krux Company"
In the world of Responsible Investing (RI), Malcolm McPartlin, Portfolio Manager at Aegon Asset Management, has voiced concerns about the difficulty of keeping track of everything related to ESG ratings. This is due to the ambiguity, subjectivity, and differing convictions within the RI universe.
The landscape of ESG rating providers is diverse, with each agency employing varying methods, weightings, and definitions for key metrics. This diversity makes comparisons across ratings difficult and inconsistent. Furthermore, a lack of transparency and disclosure from some agencies adds to the opacity, making it challenging for investors and stakeholders to understand differences or verify ratings.
The subjectivity in weighting ESG factors is another significant challenge. Different convictions about what is most material or important in environmental, social, or governance issues lead to subjective choices in scoring models, fostering disagreements between rating providers.
Greenwashing and data quality issues also pose a problem. Companies may manipulate disclosures to appear better on ESG metrics without making substantive changes, undermining the reliability of the ratings. This, combined with varying reporting standards, makes it difficult to pin down "true" performance.
As companies produce more and lengthier sustainability disclosures, data overload and variable quality complicate benchmarking and consistency in ratings.
Despite these challenges, McPartlin highlights that a strict bottom-up approach could provide a solution, as it is best able to capture the nuances, products, and values of individual companies. He also mentions a cross-agency consolidation is happening, which could potentially lead to more objective, comparable ESG ratings.
In Germany, rating agencies take a different approach, interviewing both the fund manager and the company to learn about their philosophy, processes, and convictions. This approach emphasizes the need for rating agencies that understand what companies do and how they act.
Interestingly, tobacco companies can perform well in ESG evaluations due to strong corporate governance, diversity, and integration, and a good sustainability report. This underscores the subjective nature of ESG, as completely contradictory views exist on identical topics and questions within the ESG-rating agencies.
Addressing these challenges requires standardized taxonomies, mandated methodological transparency, and improved data quality to move toward more objective, comparable ESG ratings. The sustainable revolution has given RI a stronger significance, and standardization is considered a good step. However, the qualitative nature of sustainability and governance will remain, ensuring that the debate and gray areas will always be a part of the ESG landscape.
[1] Source: Harvard Business Review [2] Source: Financial Times [3] Source: McKinsey & Company [4] Source: S&P Global [5] Source: World Economic Forum
- The diversity in ESG rating methods, weightings, and definitions, combined with a lack of transparency and discrepancies in data quality, makes it challenging for investors and stakeholders to compare and verify ESG ratings, justifying the need for improved standards and methodological transparency.
- In the pursuit of more objective ESG ratings, there is a growing call for cross-agency consolidation and standardized taxonomies, as well as addressing greenwashing and data quality issues through mandated methodological transparency and improved data quality, highlighting the ongoing debate and gray areas in the ESG landscape.
