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Sustainability ratings: Between growth and chaos

November 10, 2020

reading time: 7 minutes

by Simon Usborne, guest author

Sustainable ratings investments

Stars, points, percentages for your portfolio: Who has an overview of all the different sustainability ratings? 

Amid the turbulence of the coronavirus pandemic, some trades have been brisk. Supermarkets, video conferencing services, dog breeders, face mask makers – all are riding high. Other buoyant markets are a little more abstract. Take, for example, sustainable investment ratings.

By late August, as some of us approached six months of lockdown, investors had put record amounts of money into sustainable investment funds. Between April and June alone, more than 70 billion US-dollars had flowed into funds working according to high environmental, social and governance (ESG) principles, pushing total ESG assets above one trillion US-dollars, according to Morningstar, a leading player in impact investing research.

Insecurity hinders investments

This represents less than 2% of the total held globally by investment funds, but managers had already observed a significant shift in demand, from the consumer level up, for more socially responsible investing. This was at once a moral imperative for investors, and a means of exerting pressure on companies to do better. Heightened awareness of the climate crisis, the global movement against racism, and the shock of the coronavirus have accelerated that change. 

But how do investors compare one fund to the next? Into the growing market have stepped an array of indexes, rankers and raters. All work in slightly different ways, weighting various attributes. For some investors, confusion can be the first barrier to ethical investing. Meanwhile, critics of ESG have called for tighter regulation and standards in a rapidly evolving sub industry.

Infarm vertical urban farming
No "sin industries": The concept of sustainable investments is nothing new.

The concept is not new, of course. The moral management of money has been central to faiths including Judaism and Islam for thousands of years. More recently, in 18th century North America, the Methodists eschewed investments in companies manufacturing liquor or tobacco products or promoting gambling.

The Quakers then similarly swerved “sin” industries, forbidding investment in slavery or war. Vietnam War protesters demanded an end to the investment in defense companies by university endowment funds. 

But it has only been this century that impact investing and ESG have become formalized, at least to some extent. In a landmark move in 2006, the UN launched its Principles for Responsible Investment, to which more than 2,000 asset managers have now signed up, including LGT.

Neither regulated nor audited

The first thing ratings providers have to do is decide which factors are relevant to a given company. At Sustainalytics, one of the biggest agencies in the game, companies are given “exposure scores” for factors in 138 “sub-industry” groups. The weight is adjusted so that, for example, an oil company is judged on climate change in a different way to a software firm.

Vigeo Eiris, based in Paris and now owned by credit ratings agency Moody’s, judges companies in 40 industries against 38 “sustainability drivers”, and also has weighted scores. RobecoSAM, a Zurich-based investment company founded in 1995, focuses on sustainable investments and has its own, widely used index – and another for ranking whole countries.

Rating sustainable investments sustainability
Ratings uncover empty promises too.

At Thomson Reuters, dozens of scores make up its ESG coverage of more than 6,000 public companies. So, to get detailed for a moment, “TRESGENERS” is the code for an emissions score, or the company’s commitment to and effectiveness in reducing the carbon impact of its production and operations. TRESGSOWOS is the workforce score, which takes in diversity, development opportunities and job satisfaction, while TRESGCCS considers “controversies” and media coverage of negative events related to ESG.

Other big players, among dozens of agencies and firms offering ESG research, are MSCI and S&P. LGT, meanwhile, has been involved since almost the start of the century, first introducing a clause for responsible investing in 2003.

Sustainable investing investments rating lgt
Andrea Ferch, LGT Head Sustainable Investing

A proprietary rating tool powers the LGT Sustainability Rating. The company rating takes into account three elements: business operations, including company carbon emissions, water consumption and health and safety standards; the environmental and social impact of a company’s products and services; and controversies related to a company's operations, products and services like, for example, a toxic waste discharge into a river. “This holistic approach provides a realistic picture of a company’s sustainability quality,” says Andrea Ferch, LGT’s Head of Sustainable Investing. The rating ranges from one star (poor) to five stars (excellent).

Established players are considered reliable, but the sheer number of indexes and providers, along with big growth in the sector, is fueling calls for more oversight. Unlike credit ratings, ESG ratings are not regulated or audited, leaving it up to providers to crunch data in a fair and comparable way – and to companies to provide legitimate data about themselves.

Better ratings, more returns

Discrepancies suggest this doesn’t always work well; this year it emerged, for example, that 20 sustainable funds had invested in Boohoo, the fast fashion retailer hit by allegations of bad working practices.

Meanwhile, ratings often don’t match each other. Last year, S&P Global cut its rating for Facebook over growing concerns about privacy and transparency, but the tech giant’s score with MSCI remained “average” throughout. A recent MIT study found that scores lined up only 60% of the time. Smaller companies have complained that limited resources leave them with lower ratings regardless of their true impact.

sustainable investments
Beyond Monopoly: Sustainability and returns are no opposites.

Concerned that this flux opens the door to companies who overstate their ESG credentials, the European Securities and Markets Authority said earlier this year that the certification process would benefit from stronger “registration and supervision”.

It seems inevitable that, given the growth in this field, oversight will grow too. In the meantime, there have been signs in this year of extremes – in the climate as much as the markets – that ESG investing is paying off, outperforming the wider stock market. Their low exposure to oil and gas has certainly helped but a study published by Morningstar in June found that the majority of ESG funds had done better regardless of the chaos of 2020. 

This kind of trajectory may yet boost further the record levels of investment in ESG funds, with a positive knock-on effect on the burgeoning ratings sector – and the widespread calls to tighten it up.

Sustainable investing at LGT

LGT has introduced a sustainability rating to support its clients when making investment decisions in a way that takes ESG criteria into account: the LGT Sustainability Rating for equities, bonds, funds and ETFs. The rating is carried out using an in-house rating tool that has been successfully used manage the LGT sustainability funds since 2009.

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