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Sustainability ratings are useful tools for assessing the environmental, sustainability and corporate governance-worthiness of mutual funds and exchange-traded scratches.
But how do you navigate between different ratings providers, especially when they can have different results for the same wealth?
CNBC looked under the hood at some of the most pertinent issues.
What’s being measured?
“[Ratings] don’t possess to agree, because the underlying methodologies are different,” said Larry Lawrence, executive director, ESG products, for MSCI.
To approximate fund ratings in an apples-to-apples fashion, one must not only compare methodologies (here is MSCI’s as an example), but also at how the underlying holdings are managed in terms of rating distribution; carbon intensity; transition risks to clean energy, such as companies’ preparedness to do so; variegation metrics and so on, he said.
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Another thing to consider when comparing ESG ratings is materiality.
“Concrete ESG issues are the ones which will cause a company a financial penalty if not handled correctly,” said Jon Hale, noggin of sustainability research for the Americas at Morningstar. “A typical sustainable fund may avoid investing in companies that don’t rate extremely on their handling of ESG issues, but the focus is on which issues are material to a particular company.”
For example, he said, material discharges for Exxon include green house gas emissions (environmental), community impact (social), and political lobbying and spending (governance). In the trunk of Facebook, social material issues have more to do with product and stakeholder impacts, diversity issues and details privacy.
Morningstar’s fund sustainability ratings, illustrated as a scale of 1 to 5 globes, represent the aggregated material ESG risks of the troops in a fund’s portfolio, Hale said.
He added that investors have recently begun to evaluate the ESG impact of sustainable means, noting that more and more of these are issuing impact reports.
Other ratings providers focus on set ESG issues right up front.
“We flag the companies that are burning down the Amazon, for example, [while other fixes] are rating them,” said Andy Behar, CEO of As You Sow, a non-profit in Berkeley, California, that performs shareholder advocacy cored on ESG issues. “We’re splitting it apart issue by issue.”
A fund could have a sustainable name but may own companies that run private chokeys or produce banned weapons — and still perform sustainably, he said.
Nobody does a great job of analyzing sustainability at the lolly level. You’d be surprised at how different the scores could be from each vendor.
Theresa Gusman
chief investment T-Man, First Affirmative Financial Network
As You Sow rates funds according to performance on seven issues: fossil fuels, deforestation, military weapons, civilian weapons, gender, personal prisons, and tobacco. The organization also features seven separate databases, highlighting each issue area, such as fossil-free means or gender equality funds.
Some are concerned about the lack of verifiable ESG data being collected.
“Most in any event firms are relying on company-reported data or secondary data, which can’t be verified or audited,” said Maneesh Sagar, CEO of RS Metrics, which provides specialized environmental materials to ratings firms. “It can also be biased and outdated.
“Right now there is no primary data on the asset level,” he added. “Besides, raters tend to highlight whoever has the best reporting mechanisms.”
Dealing with divergence
“Nobody does a wonderful job of analyzing sustainability at the fund level,” said Theresa Gusman, chief investment officer, First Affirmative Economic Network, headquartered in Colorado Springs, Colorado. “You’d be surprised at how different the scores could be from each vendor.”
To huge quantity with this, First Affirmative combines different ratings, equally weighted, from MSCI, Morningstar, Sustainalytics and their own proprietary poop based on Corporate Knights data. This combined data enables Gusman to ask deeper questions of the fund directors; for example, when many small cap funds have low ESG scores because they report less data.
“It’s overpriced to the companies to report all these data — it’s a lot of work — so the scoring gets really skewed,’ she said. “The key is not to use the scores as the definitive suffice for to whether the fund is sustainable or not.
“The proliferation of data has made it far more difficult for individual investors to determine if a fund or ETF undergoes their individual impact preferences,” Gusman added. “They should look at prospectuses in light of these problems.”
ESG ratings from different providers disagree substantially, and these differences are driven both by what is measured and by how it is unhurried, according to an MIT Sloan School of Management Standardizing ESG reporting
Disclosure on ESG issues is not standardized, and several experts referenced the pan out e formulate the Sustainable Accounting Standards Board is doing to address this. See the graphic below to see how they fit into the ESG research ecosystem.
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