Unlock the Secret to ESG Scores: Learn How to Invest in Companies That Save the World!

Choosing an investment based on ESG standards can take time and effort. This is because there is no single ESG scoring system for all companies: each rating agency measures each company against its own standards.

In this article, we’ll review what constitutes an ESG score, some of the largest ESG rating agencies, and the inherent issues we still face in using these metrics to gauge a company’s real risks and opportunities across the domains of environmentalsocial and government standards.

key takeaways

• ESG scores are not standardized. Individual rating agencies calculate them, so they vary widely.
• ESG scores are typically assigned a numerical value from 1 to 100 or 1 to 10. Some agencies also use a letter rating system.
• ESG scores are relative, which means that if a company is outperforming its peers in the same industry, it could have a high ESG score without being particularly beneficial to the environment or incorporating substantial diversity, equity and inclusion (DEI) initiatives. .

What is an ESG score?

ESG Scores rate companies according to three categories involving the company’s business opportunities and risks. Those categories are environmental (E), social (S) and governance (G).

ESG scores from most agencies range from 1 to 100. The higher the number, the better the score. Some agencies use different number scales. For example, one of the largest rating agencies, MSCI, uses a scale of 1 to 10.

Some rating agencies will then rank each company in terms of letter grades, with AAA being the best and CCC being the worst.

How are ESG scores calculated?

The factors that go into each ESG score and how they are weighted vary among rating agencies. This is extremely important to remember, as not all agencies will evaluate metrics according to their investment values. You may have to shop around to find the rating agency that best suits your investment philosophy.

For example, if you’re particularly interested in companies with clean energy initiatives, look into a rating agency’s system to make sure it ranks high in your score.

However, in general, these are some of the factors that rating agencies consider when calculating ESG scores.

environmental metrics

The metrics used to establish an environmental score can vary from agency to agency. For example, MSCI ESG scores typically take into account the following:

• Climate change: This can include the company carbon footprint and efforts to reduce or offset carbon emissions.
• natural capital: This category looks at how companies use natural resources, such as water sources, raw material sourcing, and efforts to support biodiversity through land use.

• Pollution and waste: In this category, MSCI looks at electronic and toxic waste and how a company manages packaging materials. In May 2022, Tesla was kicked off by the S&P 500 ESG Index due to violations of the EPA’s Clean Air Act and its waste management in California.

• Environmental opportunities: Environmental concerns are not just an area of ​​restriction or risk; they can also be an opportunity for simultaneous economic growth. Things like green building practices, renewable energy, and clean technology can attract new investors as they look to the economy of tomorrow.

social metrics

social metrics Look at how well the company manages its relationships with stakeholders. This can include paying workers fair wages, a corporation’s impact on the communities where it operates, and holding business partners in its supply chain to similar standards to those the company sets for itself.

For example, the production of cashmere sweaters requires retailers to work with both farmers in places like Mongolia and knitters in other countries. Many cashmere producers now make it clear on their website that they work with third-party organizations to ensure farmers’ welfare and fair wages. An ESG rating agency might look to certifications like this to assess a company’s social metrics.

Governance Metrics

Corporate governance is the third category and encompasses the principles of diversity, equity and inclusion (DEI), business ethics, executive compensation and fiscal transparency, among other factors.

For example, a company with a board made up of both men and women, especially if those men and women are of diverse racial and ethnic backgrounds, is likely to score higher on governance metrics than a board made up primarily or entirely. by white men.

Another critical aspect of the governance category is lobbying and political contributions. If a company invests in political parties that promote legislation considered environmentally harmful or socially regressive, it is more likely to score lower. Because of this, it is not surprising that ESG investing has become a new battleground for a culture war – more on that below.

What is a good ESG score?

When agencies calculate ESG scores in terms of numbers, they can fall into the category of poor, average, good, or excellent. For rating agencies that use a scale of 1 to 100, the levels look like this:

• Excellent: A score of more than 70.

• Good: A score between 60 and 69.

• Average: A score between 50 and 59.

Once they calculate the ESG score, the rating agency can assign a rating according to a letter system. While MSCI isn’t the only agency that rates ESG investments, it is one of the largest. This is how they implement the letter system:

• AAA or AA: These letter designations represent companies that are industry leaders in ESG standards.

• A, BBB or BB: These letter designations represent companies that align with the industry average in meeting or setting ESG standards.

• B or CCC: These companies need to catch up with industry norms regarding ESG standards.

Who calculates ESG scores and how do I find one that meets my investment objectives?

MSCI is one rating agency that deals with ESG investments, but there are several others. Here are some of the larger agencies that publish ESG ratings and examples of investors for whom their ratings are best.

• Comprehensive: MSCI, S&P Global, and Sustainalytics weigh environmental, social, and governance issues fairly evenly. Even so, there are significant discrepancies between each agency’s rating system.

• Environmental: If your main concern is climate change, you can check out the Carbon Disclosure Project (CDP) ratings. Companies can only earn a CDP rating by responding to a survey requested by a shareholder. As a shareholder, you can make such a request.

• Governance: The Institutional Shareholder Services (ISS) Governance QualityScores rank companies according to the governance portion of the ESG standards.

Potential issues with ESG scores

ESG scores are not standardized across rating agencies. As we discussed, three of the largest comprehensive ESG rating agencies—MSCI, S&P Global, and Sustainalytics—have significant discrepancies between their companies’ ratings, despite measuring in similar domains.

ESG scores can sometimes be misleading. You may be surprised to learn that ExxonMobil, one of the world’s largest oil and gas companies, is listed in the S&P 500 ESG Index. There are a couple of reasons for this.

The first is that ESG scores measure companies against others in their industry. Because Exxon scores well compared to other oil and gas companies, it made the list.

Another is that companies like Exxon can aim to appear carbon neutral, not necessarily by cutting emissions, but by committing to reduce them in the future or by purchasing carbon offsets.

In addition, ESG rating agencies often measure direct carbon emissions when assessing the carbon footprint. This means that the agency will not consider emissions from the use of a company’s products. Under this policy, a company like Tesla doesn’t get enough credit for its low-emission products, while a company like ExxonMobil can get away with having relatively environmentally unfriendly products.

For an example of inconsistencies between rating agencies, you can see that ExxonMobil earns a D score of Influence Map despite being included in the S&P 500 ESG Index.

In this way, companies can manipulate ESG ratings. They seem more environmentally or socially responsible than they are because they are doing better than others in an already troubled industry.

Recent Opposition to ESG Investing

ESG investing has become part of a recent culture war waged primarily by Republican lawmakers. The arguments vary, but they mainly focus on private investment groups that are more focused on appearing socially conscious rather than making a profit for their investors. Conservative politicians have also argued that investing in ESG-friendly companies is a kind of betrayal of investor values.

Earlier this year, conservative lawmakers in Kansas and Indiana dropped anti-ESG legislation because representatives of the two states’ pension systems opposed it. In both cases, the pension system anticipated losses of billions of dollars over the next ten years if the state government passed anti-ESG legislation.

There are legitimate criticisms of the rules for assigning ESG scores and the lack of standardization between agencies. However, it is suspect if the widespread conservative criticism of ESG investing is being done entirely in good faith.

It seems inevitable that with a population increasingly involved in fighting climate change and by supporting progressive social issues, investors will look for an avenue to invest in companies that support similar causes. The ability to do so is a natural feature of a free market.

The bottom line

You will likely enter ESG investing with noble intentions. But get ready, measuring the impact, risk and growth potential of a company is complicated. There are no agreed standard metrics for evaluating any company’s ESG efforts. Even if there are, the rating agency’s values ​​may not match your values ​​as an investor.

That’s not to say that ESG investing isn’t an endeavor worth pursuing. You can research the metrics of each rating agency to decide which aligns best with your values. You can also look into groups like hedge funds that focus on investing in ESG companies.

The charge What is an ESG score? How ESG works and how to find ESG investments first appeared in Earring.