ESG AT ANY COST?

A look behind the scenes of the sustainability rating

28. April 2021 | Sustainability

More and more investors want their investments to take sustainability into account. For this purpose, the ESG rating (Environmental, Social, Governance) has been developed. Its goal is to reflect the extent to which companies consider certain guidelines in different areas of sustainability.   In theory, an applaudable approach – as a responsible investor, however, you should take a closer look at the mechanisms behind the ratings. You will see: a high ESG score does not necessarily correspond to your very own idea of sustainability. 

AAA for an oil producer, AA for an arms dealer

The ESG score is intended to paint a comprehensive picture of sustainability. According to the ESG concept, both the considerate use of natural resources and the treatment of employees, partners and customers are important aspects of sustainability. In practice, rating agencies are facing tough challenges. How can an airline be compared with a healthcare group in terms of sustainability, for example? Agencies get around this problem by comparing companies within the same industries. However, this can give the impression that a company is good for the environment when in reality it is only the most sustainable company in its own industry. The oil producer Galp Energia is given the top rating “AAA” by the rating agency MSCI, the weapons manufacturer BAE Systems is rated “AA” and the betting provider William Hill gets an “A”, for example. The healthcare group Fresenius, a company that is fully aligned with the UN’s Sustainable Development Goals, is less sustainable according to MSCI, with a “BBB” rating.
ESG Richtlinien

(Source: own illustration)

Rating agencies disagree

Researchers from MIT Sloan Business School have found that ESG scores for the same company can differ significantly depending on the rating agency. Ratings from different agencies correlate by an average of only 61%. By comparison, the credit rating agencies Standard & Poors and Moodys agree on 99% of their ratings. How do these discrepancies arise? Agencies consider different factors in their ratings and measure or weight them according to their own perception: Examples: – Agency A attaches importance to compliance with human rights, while Agency B gives greater weight to the reduction of greenhouse gases. – Agency X measures the working conditions in a company on the basis of the dismissal rate, while Agency Y measures working conditions by the number of employee complaints against the company. Because of the divergent scores, it is difficult for investors to identify clear sustainability winners or losers. This makes it unlikely that stock prices reflect the ESG score. Questions also arise for decision-makers within companies. What actions need to be taken to improve the ESG Score? To which agency’s rating should efforts be aligned? Is there a need for action at all?

Increased risk of “greenwashing

Due to the strong increase in interest in “sustainable” investments and the fact that the ESG market has yet to be regulated, danger of “greenwashing” is increasing. This refers to measures taken by a company that make people believe it is concerned about the environment – when in reality the opposite is true. This “strategy” is so widespread that “greenwash” was included in the Oxford English Dictionary back in 2010. Last year alone, more than 80 existing funds were converted to sustainable investment strategies. “Given the high number of conversions in a relatively short period of time, it is reasonable to suspect that not every fund is taking a genuine ESG approach, or, to put it more directly: There is a suspicion that greenwashing is at play,” says Morningstar Germany Editor-in-Chief Ali Masarwah. The European Securities and Markets Authority (ESMA) wants to make the previously unregulated market for ESG ratings more transparent by introducing guidelines. The main aim is to prevent greenwashing in the future, but also to create a universally accepted definition of ratings.

(Source: “Six Sins of Greenwashing” by TerraChoice)

Small companies have a harder time

A survey by the German Berenberg Bank has shown that smaller companies, in particular, are often unable to comply with the extensive ESG requirements. These small companies often do not publish enough sustainability information. As a result, less data is available to the rating agencies, which makes it harder for them to accurately rate these small companies. Due to the investment guidelines of many institutional investors, these companies would be excluded as potential investments.

Our ideas on sustainability

It is of great concern to us not to invest in companies that violate our values and moral standards. In our view, however, a high ESG score in its current form is not yet a reliable indicator for the very complex topic of sustainability. We therefore do not offer a portfolio that meets the so-called ESG criteria. However, we pay indirect attention to some of these criteria when selecting our companies.

Estably is the first digital asset management company from Liechtenstein to offer first-class wealth management from € 20,000 through a mix of technology and human investment expertise. Thanks to the portfolio managers' many years of experience in the field of value investing, above-average returns are targeted. This is intended to make professional asset management, previously available exclusively to large investors, accessible to everyone - conveniently, transparently, and profitably.

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