ESG Ratings are just the Beginning of the Story
How ESG Ratings Work
At its core, ESG ratings assess how well a company or fund manages ESG risk relative to their peers based on long-term resilience to environmental, social and governance (ESG) issues. Each pillar in ESG highlights different critical issues being addressed across the world.
Environmental factors look at the impact of a company’s business activities on the environment, including water conservation, renewable energies, and waste responsibility.
Social factors have to do with how a business treats and values people. For example: diversity and inclusion, safe work conditions, and human rights protection.
Governance factors focus on corporate policies and how the company is governed, including risk management, protecting shareholders, bribery, and corruption.
A company’s environmental and social factors are assessed based on industry, as each industry faces different operational risks. However, due to its universal importance, governance is assessed somewhat equally across all companies. ESG ratings look at a company’s bottom line strategies for addressing these risks and compares them to the peer group. ESG fund ratings cover similar metrics but on a fund-wide basis and are assessed based on the level of impact a fund will have as determined by each company’s ESG score and long-term impact.
ESG Ratings Agencies
MSCI is one of the most well known companies providing ESG ratings, their ratings scale ranges from AAA (leaders) to CCC (laggards). MSCI ratings take the most relevant publicly available data and pinpoints a company’s most significant risks based on industry. From there, each key ESG risk is assigned a percentage rating based on the company’s time horizon and impact when addressing that risk. For example: if a company is looking to reduce their greenhouse gas (GHG) emissions they may look to renewably source 75% of their energy consumption over the next 10 years rather than using coal based energy; then MSCI would assess the impact of these goals on the environment based on the 10 year time horizon and potential GHG reductions with 75% renewable energy.
At Physis, machine learning, and algorithms to skim and quality check over 56 million data points as a central part of our impact investing analysis in order to provide robust insight to the impact of a portfolio. Paired with the information from our 15 data sources, Physis moves beyond ESG ratings to include other key metrics and indicators within portfolio analysis.
Understand the True Impact of your Portfolio
ESG ratings are generally used to flag opportunities or risks not identified by traditional financial analysis such as environmental impact of core business practices and how this may affect future growth potential in a given industry. These ratings can be incorporated into fundamental or quant analysis, portfolio construction, risk management, and benchmarking.
Without a doubt, if you are an institutional investor, incorporating sustainability into your investment thesis is a key value add in 2022 and beyond. ESG rating is a great starting point for understanding the impact of a specific portfolio. Beyond ESG ratings, Physis incorporates other key impact indicators such as alignment to the UN Sustainable Development Goals alongside our sustainable product research on over 2,000 companies, and more than 700 other key metrics such as water management, gender equality, and more.
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