As an experienced institutional investor, I must admit I am both amazed and bewildered by the desire and effort to homogenize opinion in the Sustainability/ESG ratings space. There is so much going on here that needs to be unpacked, and a related story from IPE.com offers an excellent opportunity to discuss it. I will try to be brief, but the lunacy of this endeavor may win the day and force me to drone on relentlessly. Apologies in advance.
The story notes with wonder that (based on a study of 30 asset managers) company ESG scores produced by investors are even less aligned than those of ESG rating agencies. The tone of incredulity makes it clear that these scores should closely align in both cases, yet for some inexplicable reason they do not.
Let’s all say it together … “that’s what makes a market.” Like sell-side analyst ratings and advice from proxy advisory firms, ESG ratings are opinions which have been purchased. If a portfolio manager or an index provider blindly relies on them to simplify their job, then you know who to blame when the wheels fall off. The truth is that there is no reason to try and force these opinions closer together. In fact, attempting to do so eliminates the value inherent in the diversity of the views expressed. Better disclosure on how the ratings are derived would certainly be welcome, (these providers have historically been reluctant to disclose in any real detail their methodologies, and so we don’t truly know what each is actually measuring), but that’s as far as this has to go. Any legislative or regulatory effort beyond is obviously (to me, anyway) overreach.
If you pay for a service which provides an opinion and you find that opinion well-reasoned and thoughtful, you should continue to pay for it and use it as one of the inputs in the formation of your own opinion. Conversely, if you rely on it blindly to create an ETF or build an actively-managed portfolio, you have effectively outsourced your professional judgement and failed in the execution of your fiduciary duty. Company sustainability data must be considered within the context of all other relevant data (balance sheet quality, earnings and cash flow, quality of senior leadership, security liquidity, client or portfolio risk tolerance, etc) in order to reach optimal portfolio construction outcomes.
Competent money managers would never rely solely on the opinion of a single sell-side analyst. So it’s time to put on your big boy pants (thought about being gender neutral, then decided to let this one go) and take up the challenge of properly incorporating company sustainability data instead of attempting to shamelessly outsource your work. Seriously, isn’t that what people are paid to do?