Evaluating The Use Of ESG Rating Providers

ESG Ratings are big business. Given the flow of capital into ESG related funds and strategies, asset managers have responded with differing degrees of sophistication. And many still rely upon off-the-shelf third-party ESG rating agencies. Is that sufficient?

The usefulness of third-party ESG rating agencies depends on what you are trying to achieve. From a marketing perspective to retail investors it may be sufficient, and mask any shortcomings in an asset managers investment process.

For professional investors, an outsourced solution that integrates ESG ratings into a stock buy/sell decision is less convincing. A thorough understanding of the scope and construct of third-party ESG ratings uncovers a myriad of limitations that explains why.

To find the best ESG investment managers, investors need to dig deeper into the investment process. And try to differentiate between the tangible value-add of externalised ESG rating reliance, and proprietary internally generated ESG ratings. Adding to this complexity is ESG rating subjectivity as investors consider emerging markets.

To find the best ESG managers, external ESG rating providers may not provide sufficient insights across all sectors and countries. But this will only become apparent to manager selectors as they perform their investment due diligence.