By Chea Srun | XQuant
Global rating agencies such as MSCI, S&P Global and Sustainalytics provide to their clients comprehensive analysis of ESG risks and also scores of the companies they cover. Those assessments are either based on questionnaires to companies or based on public or private data, with a feedback loop to make sure that the companies are involved in the process.
Many professionals working on ESG (fund managers, risk managers, financial analysts) often complain that the ESG scores are not consistent across raters, which make them confused about what information they should rely on.
The chart below shows a few examples of ratings dispersion across different sectors:
Source: Refinitiv, Bloomberg, MSCI, Yahoo Finance, Moody’s, Fitch, S&P; OECD calculations
Such a dispersion is not observed for credit ratings. The chart below shows that Moody’s Fitch and S&P all have rather consistent ratings:
So why such an inconsistency exists for ESG ratings, while it doesn’t happen for credit ratings? Is it a matter of methodology? Is it a matter of the data they use? Or is it the quality of the ESG disclosure?
Several researchers from the University of Oregon and Harvard University (*) found that surprisingly the disclosure appears to amplify disagreement among raters. In other words, the more a company discloses its ESG data, the more likely the agencies are going to disagree on the ESG assessment.
In fact, in the absence of disclosure, agencies are “more likely to agree because they use similar rules of thumb and importation techniques”. In contrast, when companies make higher level of disclosure, agencies “need to make a judgement about whether the disclosure means good or bad performance”.
How can investors deal with those diverging information? Which agency should they trust to make decision on their portfolios?
We believe that each agency provide a valuable view of the ESG risks and opportunities, but investors have to make their own judgement. There is no other solution than looking in details the reports and analysis and actively searching ESG information when investors identify any material issues. For example, if the investor finds out that one given governance issue is the reason contributing to the disagreement, he should use his own assessment of the materiality of the issue and then search for the related information.
As ESG investor's awareness keep increasing and also become more and more sophisticate, we believe that the trend will be for them not to entirely rely on the rating agencies, but look for other alternative data to form their own view.
(*) Why is Corporate Virtue in the Eye of The Beholder? The Case of ESG Ratings
- Dane Christensen , George Serafeim, Anywhere Sikochi - December 2020