ESG is becoming the cornerstone to how some endowments and foundations invest. For many, the investing funnel starts at ESG and then narrows at relative value.
Sectors tend to be scored relative to other sectors. Within sectors, companies are scored relative to their peers. The energy sector, for instance, doesn’t score well in E or S outright but the E&Ps that are efficient in water usage and have good safety records get scored higher relative to their peers. G is typically a layup for most large cap companies with proper risk controls and diversification of ownership.
Governance matters to insitutional investors.
The boom in responsible investing worldwide throws up a key question for borrowers, fund managers and index compilers: How exactly do you evaluate and compare responsible investments? A whole industry has grown up to try to provide answers. It looks beyond financial performance to score companies and investments on criteria including their environmental friendliness, social impact and governance — shorthanded as ESG. ESG ratings are increasingly taken into account in decisions on where to invest or allocate capital. But there’s debate over whether they can truly buffer against financial risk or even act as a guide to better-performing investments.
1. What are ESG ratings?
They help companies, investors and other finance professionals factor environmental, social and governance criteria into their decisions. They can help gauge whether a company is a global citizen, or how well it’s handling risks with potentially costly consequences. A rating can cover a long list of diverse factors including carbon emissions, water usage, gender equality, fair labor practices, human rights, crime-prevention controls, board composition and shareholder rights. There’s no single method for scoring or ranking companies. Some ratings companies rely on analysts, while others focus on quantitative information or company-provided data. They can analyze a company or fund for how transparently it reports such issues, or how well it stacks up against competitors or its own performance over time.