ESG Ratings - third party "scores" on public (and some private) companies - are one of the foundational elements of current ESG analysis. However, per SEC Commissioner Hester M. Pierce, in a speech in June 2019:
There is, for example, a growing group of self-identified ESG experts that produce ESG ratings. ESG scorers come in many varieties, but it is a lucrative business for the successful ones. The business is a good one because the nature of ESG is so amorphous and the demand for metrics is so strong. ESG is broad enough to mean just about anything to anyone. The ambiguity and breadth of ESG allows ESG experts great latitude to impose their own judgments, which may be rooted in nothing at all other than their own preferences. Not surprisingly then, there are many different scorecards and standards out there, each of which embodies the maker’s judgments about any issues it chooses to classify as ESG. The analysis can appear arbitrary as it may treat similarly situated companies differently and may even treat the same company differently over time for no clear reason. Putting aside the analysis that produces the final score, some ESG scores are grounded in inaccurate information.”
And yes, Commissioner Pierce was appointed by President Trump. But does she have a point?
Commissioner Pierce makes a range of arguments, including:
Hmm. And criticism of ESG ratings does not come only from the political end of the ESG spectrum. In academia, Sakis Kotsantonis and George Serafeim dig into these issues in “Four Things No One Will Tell You About ESG Data”:
What does this mean for institutional investors?
Castle Hall does not provide ratings on underlying investments, be they the stocks or bonds of publicly traded companies, or private investments in the portfolio companies held by PE partnerships.
We do, however, focus on the investment process of asset managers: while a manager may talk a good marketing story, do they actually comprehensively integrate ESG criteria into each step of the investment decision making process - or is it marketing fluff and potentially greenwashing? Running a strategy which has added a few screens based on a quick subscription to a single ESG data provider would certainly seem to run close to the latter.
When allocating to third party asset managers purporting to follow an ESG strategy, asset owners cannot simply "tick the box" if a manager declares that it has engaged an ESG service provider to "rate" underlying investments. It is essential to ensure managers recognize any shortfalls or potential shortcomings in their vendor’s research. Is the manager actually cognizant of the limitations of their service provider’s methodology? Are they conducting any in-house ESG research to complement their service provider’s? At what stage of the investment process is the manager using this research - initial screening, or final stock selection?
These are questions institutional investors, outsourcing the investment process to external managers, can usefully ask when evaluating a manager's investment strategy.
There is, unfortunately, rarely a simple answer to a complex question.
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