ESG Club
Alex Parkinson is co-head of responsible investment data integration at Newton Invest- ment Management
MAKING SENSE OF DIVERGENT ESG RATINGS
Third-party environmental, social and governance (ESG) ratings play an impor- tant role in asset management, but we believe their application needs to be bet- ter understood. Newton has long held the view that exter- nal ESG ratings or scores should not be used in isolation when assessing compa- nies, but as an input into the process. Our consideration of ESG issues more broadly is part of a multi-dimensional research approach that takes account of financial analysis, thematic trends, macro-econom- ics, investigative research and valuation considerations as appropriate. We believe sustainability is a fundamen- tal part of the mosaic of issues required to fully appreciate the material risks and op- portunities influencing the securities and instruments in which we invest on behalf of our clients. External ESG ratings pro- vide an opinion that is independent of the asset manager, and can therefore function as a counterweight to internal views. ESG rating datasets also offer wide cover- age across a universe, which can help in monitoring ESG risks within portfolios,
as well as providing a view supporting the screening for new investment ideas. Nonetheless, it is important to acknowl- edge that the information on which third- party ESG scores are based is subjective and dependent upon often opaque meth- odologies. It is based on unaudited data and is proprietary to the data vendor. We believe that simply taking third-party ESG ratings at face value could result in the mispricing of securities or the inap- propriate inclusion of securities in sus- tainable portfolios. Indeed, the choice of one ESG vendor over another could strongly determine the investment outcome. With this in mind, we find a paper distrib- uted by the Centre of Endowment Asset Management (CEAM) at Judge Business School, Cambridge University, helpful. The November 2020 paper, Divergent ESG Ratings, is authored by Professor Elroy Dimson (CEAM), Professor Paul Marsh and Dr Mike Staunton (London Business School). The authors point to a substantial disparity in the rankings of 878 companies across two leading ESG rating providers.
Inconsistency is further illustrated in an in-depth analysis of the ratings of six com- panies which diverge significantly across three ESG rating agencies in terms of their overall ratings and even in the pil- lars that comprise those overall ratings. An implication of this disparity is that asset managers need to build capacity to manage and interpret the data that they buy. This requires a dedicated ESG data focus and function, supported by a data strategy that aims to plug gaps or weak- nesses in available data.
PI Partnership – Newton Investment Management
The data that lies behind headline ESG ratings is often the most useful aspect of the datasets that are available. For us, the most effective method is when this under- lying data can be integrated from multiple ESG providers in a way that makes the most sense for the asset manager. Of course, not all the data within an ESG rating will be relevant or aligned with the fundamental view of the asset manager or the interests of its clients, and it is up to asset managers themselves to identify the data points that are most relevant to them. This is a difficult exercise, even when working with the raw data that underpins many ESG ratings. Data consistency is a challenge here too, since the same data point can vary across providers, owing to different methodolo- gies for data collection and estimation. We have seen considerable variation in carbon-emissions data, for instance, across three providers when comparing data for individual companies. Newton welcomes the CEAM paper as part of a growing body of literature that shows the disparity in ESG data by high- lighting inconsistencies and biases across data providers – in terms of the inputs to the ratings and the divergence of outputs. We believe that this type of research may be increasingly useful for asset managers, companies and ratings agencies as regu- lators in several jurisdictions – including the EU and India – have been pushing to regulate the ESG ratings market. It is also helpful as
asset managers strive for
greater transparency in their sustainable investment processes and the data that underpins them, and for enhancements to their investment decision-making.
Important information This is a financial promotion. These opinions should not be construed as investment or other advice and are subject to change. This material is for information purposes only. This material is for professional investors only. Any reference to a specific security, country or sector should not be construed as a recom- mendation to buy or sell investments in those securities, countries or sectors. Newton manages a variety of investment strategies. Whether and how ESG considera- tions are assessed or integrated into Newton’s strategies depends on the asset classes and/or the particular strategy involved, as well as the research and investment approach of each Newton firm. ESG may not be considered for each individual investment and, where ESG is considered, other attributes of an investment may outweigh ESG considerations when making investment decisions. Issued by Newton Investment Management Ltd. ‘Newton’ and/or ‘Newton Investment Management’ is a corporate brand which refers to the following group of affiliated companies: Newton Investment Management Limited (NIM) and Newton Investment Management North America LLC (NIMNA). NIMNA was established in 2021 and is comprised of the equity and multi- asset teams from an affiliate, Mellon Investments Corporation. In the United Kingdom, NIM is authorised and regulated by the Financial Conduct Authority (‘FCA’), 12 Endeavour Square, London, E20 1JN, in the conduct of investment business. Registered in England no. 01371973. NIM and NIMNA are both registered as investment advisors with the Securities & Exchange Commission (‘SEC’) to offer investment advisory services in the United States. NIM’s investment business in the United States is described in Form ADV, Part 1 and 2, which can be obtained from the
SEC.gov website or obtained upon request. Both firms are indirect subsidiaries of The Bank of New York Mellon Corporation (‘BNY Mellon’).
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