In the past year, asset managers and investors have increasingly been using ESG ratings to more effectively inform investment decisions.

However, as there is no single, accepted methodology for calculating ESG ratings, various ratings agencies often have wildly different assessments of the same company, which can prove frustrating. Further complicating the problem is the fact that most data used in ESG ratings is retrospective, making it challenging to foresee how resilient companies are to future risks without the aid of supplemental data analysis.

To gain a clear picture of how ESG factors potentially impact a company’s long-term performance, asset managers should better understand how ESG ratings are derived, focus on the right ESG data providers for the markets they are targeting, and understand what in-house research they need to supplement the external data that is available.

Commonly used ESG ratings

The following ESG rating agencies cover the majority of global large cap companies and are the most commonly used amongst asset managers and investors. All of these ESG ratings are available on the Bloomberg terminal and some are also available to the public on the web:1

  • RobecoSAM Total Sustainability Rank – ranks companies against industry peers across E, S and G metrics
  • Sustainalytics ESG Risk Ratings – Measures a company’s exposure to industry-specific material ESG risks and how well risks are managed
  • ISS Governance Quality Score – Identifies corporate governance risks based on board structure, shareholder rights, remuneration and audit
  • CPD – measures the level of commitment to climate change mitigation, adaptation and transparency

These ratings agencies use a combination of company disclosures, publicly available resources and proprietary research. Some providers will use AI technologies to scan the internet for news and developments that might affect the company’s rating.

Currently, there are roughly 30 significant ESG data providers around the world, including the major agencies listed above. However, less than a handful of these have global coverage. In order to tailor to the diverse and growing needs for ESG data in Greater China, a number of boutique data providers are emerging to provide information on companies in the region.

Using ESG ratings

Asset managers can use ESG ratings to help evaluate a company’s value and creditworthiness for equities and fixed income securities respectively.

Equity – On the equity side, a company’s ESG performance is a potential indicator to asset managers and investors of how well it is managing the ESG-related risks it is exposed to. Better management of those risks versus peers may give that firm a competitive advantage and increased profits – this would in turn lower the firm’s overall cost of capital, thereby increasing the valuation of the firm.  That valuation plays a critical role in determining whether and to what extent an active asset manager should hold that stock in her portfolio.  Passive or index managers can also ESG ratings as a foundation for their stewardship/engagement activities. 

Fixed Income - For debt instruments, ESG rating information is used to support creditworthiness assessments, particularly in relation to climate-related risks. The ratings are used to assess how these risks are impacting a company’s overall risk profile, its credit rating and its ability to service debt in the future.

Making the best use of ESG data providers

Asset managers and asset owners often ask which rating system(s) are better and why.  Somewhat unsatisfactorily, the answer is that “it depends” – on the investment strategy being pursued, the investment process being executed, and the risk/return profile being sought.  Our recommendations include the following:

  • Assess ESG ratings from various providers with your investment process/strategy in mind. For example, if your portfolio is predominately large cap international companies, ratings from companies like MSCI and Sustainalytics may provide useful. On the other hand, if your portfolio consists of companies in jurisdictions where ESG disclosures are immature, e.g. Emerging Markets and China, you may need to perform a more localised search process by subscribing to data providers with a more robust set of data targeting these emerging markets.
  • Supplement ratings data with in-house research and consider sourcing from more than one data provider. In our view, reliance on a single source of ESG data is unlikely to give portfolio managers sufficient confidence to influence their investment decisions. Leading firms are augmenting provider-based ESG data sets with information from their stewardship/engagement functions in order to come to a more informed view on stocks and bonds.

Although ESG ratings are not perfect, they serve an important role in providing a snapshot of a company’s performance to support more sustainable investment decisions. We believe asset managers should make use of this data, as well as applying  their own research.  It is only through constant engagement and feedback from asset managers that the universe of ESG data and ratings can improve over time.

KPMG helps our clients understand how to balance all these factors and make informed choices. If you would like to discuss these topics in more detail, please feel free to contact Neil Macdonald, Head of Wealth and Asset Management and Jocelyn Ho, Manager, Sustainability Advisory.

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation.

1 All of the listed ratings are accessible on Bloomberg Terminal. CSRHub provides free ESG ratings while Sustainablytics’ ESG Risk Ratings can be accessed via Yahoo Finance
This article was originally published on Neil Macdonald, Head of Wealth & Asset Management Centre of Excellence, KPMG in China and Jocelyn Ho, Manager, Sustainability Advisory, KPMG in China.