Understanding how ESG is measured is no small feat and navigating the universe of ESG metrics and indexes could outsmart even seasoned investors. It may sound like a noble idea to measure how “ESG friendly” a certain stock or ETF is, but be prepared to face huge hurdles if you actually want to do it.
Confusion of abundance
A simple online search will yield hundreds of different ESG ratings, rankings and indexes, each using a different methodology. The result is utter confusion when it comes to determining how well a company performs from an ESG perspective.
The nonstandard and misleading nature of various ESG scorings prompted the Massachusetts Institute of Technology (MIT) to launch an initiative called The Aggregate Confusion Project. Researchers at the MTI Sloan School of Management found that the ESG ratings of different providers diverge substantially, with an average correlation of 0.54 between them. Take Apple as an example. While Sustanalytics assigns low ESG risk to the tech giant, the risks are average at MSCI and S&P considers the stock weak from an ESG point of view.
Even if the ESG scores of a given company or investment vehicle are consistent, the results can still be misleading. Let’s take a look at H&M. The Sweden-based multinational clothing retailer has a solid ESG rating at MSCI, Sustainalytics and S&P Global. But if you check the news, you will find some serious red flags. Reliable international news outlets like Bloomberg and Forbes, reported that H&M was burning clothing alongside recycled wood and trash. Not exactly climate positive, to put it mildly.
Challenge of measuring
As we have seen, ESG factors are not standardized and it’s not immediately obvious how they can be measured. This is not surprising if you take a second to consider how a firm can be measured from a business ethics or human rights perspective. The measurement of greenhouse gas emissions may sound easy, but if a company manufactures 10,000 products manufactured from five materials provided by different suppliers, it becomes complicated. Measuring the given company's greenhouse gas emissions would mean measuring the emissions generated by each supplier during production and transport.
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Even though the number of ESG metrics, scores and ratings is overwhelming, we collected the top ESG rating providers to help you put ESG investments into some perspective.
The measurements, the metrics used for measurement, and the weighting of the different categories differ, however, at all four providers.
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Having such a huge focus on sustainability performance is admirable, but we must recognize that no measurement can provide a single source of truth. Check out this article if you want to know more about setting up an ESG investment strategy.