ESG ratings: altogether different ratings pose a problem for fund managers

For all its fast growth and multibillion-dollar inflows, environmentally conscious funds harbour a dirty little secret: companies’ ESG scores are less reliable than they appear.

Norges Bank Investment Management, which oversees a chart-topping $1.4tn portfolio, is the latest to blow cover on the ESG ratings produced by companies. “We rarely, if ever, use the ratings numbers,” Patrick du Plessis, global head of risk monitoring, told Bloomberg in an interview.

This is big business. The 4,000-plus signatories to the UNPRI — a network of investors focused on responsible investment — represent more than $100tn in assets under management and ESG funds are among the fastest-growing. ESG rating agencies proliferated until consolidation took over a few years back. In 2019 Moody’s bought industry pioneer Vigeo Eiris.

Yet there is little agreement around methodologies, weightings and other inputs when it comes to ranking companies. That was laid bare by a recent analysis of six ESG rating providers’ scores of 400 companies, carried out by chartered financial analysts.

MSCI’s correlation with S&P and Sustainalytics — three big providers of ESG ratings — was sub-50 per cent. By comparison, the big three credit rating agencies have correlations of 94 to 96 per cent on long-term debt ratings.

Academic studies have shown a similar pattern of conflicting ratings due to methodologies, measurement or aggregation. This can vary across companies. One paper published last December, by Florian Berg, Julian F Kölbel and Roberto Rigobon, found “substantial disagreement” over companies with high rankings such as Intel Corporation and GlaxoSmithKline as well as those among the worst-rated, such as Porsche Automobil Holding and Philip Morris.

Such discrepancies bring problems for fund managers, companies and the planet — mixed signals mean it is far harder to up your game than if everyone agrees where you are going awry.

One solution suggested by the trio is for fund managers to apply their own weighting: those deeply concerned with child labour, say, can put a bigger weighting on that. But there should be consistency across sectors on how carbon emissions, say, are measured and weighted in the absence of companies providing the information.

Alternatively, portfolio managers can follow NBIM’s lead and do their own work. But that is unlikely to be an option for smaller, less well-resourced houses. Better for the ESG rating agencies to standardise.