Critics of environmental, social and governance fund ratings often cite numerous reasons as to why the ratings lack validity. While the ratings aren’t perfect, we explore some of the reasons why we believe they are worthwhile and how they may continue to improve.
Rating ESG Funds
One common argument regarding the validity of ESG ratings is that there are hundreds of ESG data, analytics and research providers, and that their scores are sometimes conflicting, making it difficult to draw conclusions. The reality is that there are only a handful of prominent ESG research firms, most notably Sustainalytics and MSCI.
These firms have long played an important role in gathering and assessing information about companies’ ESG practices. This has been and remains a considerable challenge. Company disclosures on ESG practices have always been voluntary, are rarely audited, and are not standardized.
But the quality and quantity of ESG data continue to evolve and improve. And, as companies realize that risks to their brands and reputations could harm their social license to operate, they are increasingly disclosing their ESG practices. In fact, in 2011, only 20% of companies in the S&P 500 published a sustainability report, increasing to 86% in 2018.
Investigating Reported Data
Criticizing the ratings requires an assumption that ESG ratings providers simply take ESG data reported by companies at face value, with no further investigation. This is simply not true.
Rather, these ESG research firms employ hundreds of sector-focused analysts who have expertise in evaluating and contextualizing ESG data. These analysts take company-reported data sets, along with data collected by machine learning and natural language processing from a variety of industry, nonprofit and news sources, and assess it in the context of that particular company and its industry. This analysis is necessary in order to determine the extent to which company policies, programs, and ESG performance meet industry best practices, and to measure the operational, legal and reputational risks posed to companies.