ESG – Not as easy as ABC

The rise of ethical investing has resulted in many investments being assessed on an ESG (Environmental, Social and Governance) basis as well as on a traditional, financial basis. Many people now want investments which will not only produce a return, but which are ethically acceptable too.

In turn, this has led to a desire to simplify ethical investing, so that people can easily identify investments which are suitable from an ESG basis. The ratings agencies which analyse investments from a conventional perspective have started to produce ESG ratings too – the idea being that, in order to make things simple, you can choose only to have investments which have high ESG ratings, and you can be certain that you are making ethically acceptable investments.

But there’s a problem – unlike conventional financial ratings, nobody really agrees about what an ESG rating should measure, or how it should be measured. Cultural differences are important – British people have a different view about the ethics than people from other countries. Perhaps the clearest example of this is in our view of our guns and weapons – the American view is that guns are fine from a moral standpoint, and that only “controversial weapons” should be excluded from an ethical portfolio. It’s also important to recognise that views can change over time – since the start of the war in Ukraine, ethical investors have, anecdotally, become more accepting of weapons manufacture. At least while they’re being sold to “the good guys”.

This means that we need to take care when we look at ESG ratings. A recent academic review carried out by Florian Berg, Julian F Kölbel, and Roberto Rigobon (http://revfin.org/aggregate-confusion-the-divergence-of-esg-ratings if that’s your idea of a good read!) looked at the five prominent ESG ratings agencies, and found, frankly, that they couldn’t make their minds up about whether companies are good from an ESG perspective (technically, they said that the correlation between two providers is only somewhere between 0.38 and 0.71, where 0 is no correlation and 1 is perfect correlation).

This matters a lot more than you might think!

Many asset managers have recently launched ethical investment funds, which take account of ESG factors. In order to keep investors costs low, many of them simply use ESG ratings to decide which companies to include in a fund, and which to exclude. That means that investors need to understand which ratings agency the fund manager is using, and what the ESG views of that ratings agency are. It can be pretty difficult to identify which ratings agency is providing the scores and even more difficult to find out how they assess companies from an ESG perspective.

Our view is that it takes a lot of time and energy to understand ESG ratings, and, until a standard approach is in place, it is better to take advice about investing ethically, rather than just relying on ESG ratings. There are many investment managers which have devoted considerable resources and money to ethical investing and our view is that it is better to invest with managers which have demonstrated a long-term commitment to this approach.

If you are interested in investing in this way, please contact us.

Philip Wise | philip@sussexretirement.co.uk

Managing Director and Chartered Financial Planner


This guide is for information purposes and does not constitute financial advice, which should be based on your individual circumstances. 
The value of investments may go down as well as up and you may get back less than you invest. Past performance is not a reliable indicator of future performance.

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