Credit ratings and ESG ratings both have a single headline score, but that’s where the similarity ends. Here are 5 misconceptions about ESG investing:
Environmental, social and governance ratings inform much of the data around ESG investing and are the bedrock of many ESG exchange-traded funds.
ESG ratings started a few decades ago when a few firms began trying to measure the nontraditional financial information that companies were releasing. Today there are many ESG raters scoring companies; three of the largest are MSCI, Sustainalytics and S&P Global Sustainable1.1. ESG ratings are like credit ratings Credit ratings and ESG ratings both have a single headline score, but that’s where the similarity ends.
ESG ratings are rule-based and methodical and not tied to one particular analyst, says Linda-Eling Lee, managing director and head of ESG and climate research at MSCI. To gather data now, the ESG rating firms comb ESG data that corporations release, but also use alternative data, scraping the web for corporate mentions, including news stories, to include as part of the analysis. Raters also interview companies about ESG practices.3.
Sustainalytics also looks at a firm’s environmental and social impact on the world and how that is internalized into the firm’s costs and risks. Their ratings are absolute, rather than best-in-class, so companies can be compared across industries. MSCI rates the electric car maker “A,” which is the higher end of its average category. AAA is the top rating, CCC is the bottom.
5. The companies behind ESG ETFs have a standard way to use ESG ratings Institutional money managers create ESG ETFs using the subcomponents of the ESG ratings and can slice and dice the ratings however they want.
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