The challenge of ESG for investors

Lack of metrics, standards and widely accepted measurements.... Michael Even, FaithInvest's Director of Strategy and Investment Research, considers the challenge of ESG for values-driven investors.


One of my roles outside of FaithInvest is as a member of the Advisory Board of the MIT/Sloan Sustainability Initiative. The initiative focuses on sustainability education and supports many distinct educational and research efforts.


It is always exciting when two of my roles align perfectly and that is what happened recently with FaithInvest and the Sustainability Initiative.


I began writing the second of three articles I have been planning for FaithInvest; this article deals with the practical challenges facing today’s faith-based investors. In the article I touch on the biggest challenge (at least in my opinion) which is the lack of standards, metrics, and broadly accepted measurement of all aspects of ESG and Impact Investing.


One of the leaders of MIT’s Sustainability Initiative – Professor Roberto Rigobon – together with Florian Berg and Julian Kolbel wrote Aggregate Confusion: The Divergence of ESG Ratings in 2019. That paper explores, in detail, the challenges of today’s ESG ratings; it was this paper that helped me focus on the gravity of the issues as it pertains to the faith-based investment community.


Below are links to the paper, the official synopsis of the paper and a link to Roberto’s faculty site.


The paper not only shows the huge divergence in ratings between services (there are many examples of companies top ranked by one service and near the bottom of another), it also emphasises the problems with the simplistic methodology of combining various ESG indicators into an 'average score'.


To demonstrate the implications of simplistic ESG rankings, Roberto likes to joke that by reverse engineering the various ESG ranks (ESG data providers generally do not publish how their compute the overall ranking), he can tell an oil company 'how many female or minority board members it must add to make up for a major oil spill…'


The paper is technically fascinating and quite damning of today’s ESG rankings. But the paper does not do justice to the passion and thought process that Roberto conveys when he speaks about it.


He likes to explain that the only way to understand, pay attention to and solve problems is to have good measurement and transparency – and he will, hopefully, continue to drive his research towards those ends.


Clearly this issue is critically important to our members and we will be looking further at ESG in depth when our Member Portal launches in the next month or so. Please contact us if you would like to discuss this paper and related issues.

Aggregate Confusion: The Divergence of ESG Ratings

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3438533

  • Florian Berg, Massachusetts Institute of Technology (MIT) - Sloan School of Management

  • Julian F Kölbel, University of Zurich, Department of Banking and Finance; MIT Sloan

  • Roberto Rigobon, Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)

Abstract

This paper investigates the divergence of environmental, social, and governance (ESG) ratings. Based on data from six prominent rating agencies – namely, KLD (MSCI Stats), Sustainalytics, Vigeo Eiris (Moody's), RobecoSAM (SP Global), Asset4 (Refinitiv), and MSCI IVA – we decompose the divergence into three sources: different scope of categories, different measurement of categories, and different weights of categories. We find that scope and measurement divergence are the main drivers, while weights divergence is less important. In addition, we detect a rater effect where a rater's overall view of a firm influences the assessment of specific categories.


Roberto Rigobon

https://mitsloan.mit.edu/faculty/directory/roberto-rigobon


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