In “What a Difference an ESG Ratings Provider Makes!” the latest piece by Feifei Li and Ari Polychronopoulos of Research Affiliates, the team looks at how the need for ESG ratings to help investors construct portfolios in line with their ESG preferences is acute…
Unfortunately, both quality and consistency of ratings can hamper the process.
Li and Polychronopoulos compare the ratings of two well-known ESG ratings providers to highlight why investors need to have a solid understanding of their provider’s methodology.
– ESG ratings vary markedly by ESG ratings provider because each provider has a unique methodology for assigning company-specific ratings. Investors, therefore, must ensure the approach taken by the ratings provider they rely on is consistent with their ESG preferences or they risk constructing portfolios that do not align with their ESG views.
– ESG portfolios constructed using the ratings of two well-known ESG ratings providers yield large performance dispersion and low correlation of returns. The differences are even greater at the individual ratings level for environmental, social, and governance scores.
– The differences in how ratings providers calculate ESG scores can result in the same company being ranked quite highly by one provider and quite poorly by another. Understanding which metrics are evaluated and how they are assessed is essential to investors selecting stocks that meet the ESG criteria they care about.