Do Wide Divergences in ESG Ratings Doom Investors?

Six competing vendors rate how companies perform along environmental, social and governance (ESG) standards. But because those ratings differ widely across vendors, investors cannot reliably construct portfolios that meet their personal criteria.

My August 24 and November 23, 2020, articles for Advisor Perspectives presented evidence from research demonstrating that ESG investors face considerable challenges in allocating assets because the data used to construct ESG portfolios differs widely among providers. The result is that funds may not be aligned with investor objectives and beliefs. In addition, the return and risk of ESG funds can differ significantly and are driven by fund-specific criteria rather than by a homogeneous ESG factor.

Elroy Dimson, Paul Marsh and Mike Staunton contribute to the ESG literature with their study, “Divergent ESG Ratings,” published in the November 2020 issue of The Journal of Portfolio Management. They found that while data is essential for making investment decisions, and most institutions rely wholly or partly on external providers of ESG data, there is minimal correlation between ESG ratings from alternative agencies. As the following chart that shows ratings from two of the leading raters demonstrates, there is a wide divergence in scores – companies with a high score from one rater often receive a middling or low score from another rater.

MSCI versus Sustainalytics Rankings at Start-2019

Source: Data from MSCI and Sustainalytics for 878 U.S. companies.