Non-Uniform Standards For ESG Ratings Present Significant Challenges To Portfolio Managers

Although the recent focus on ESG (Environmental, Social and Corporate Governance) investments has been on the “E,” performance against environmental metrics is relatively easy to track. The metrics themselves are issued by a handful of well-known organizations working together. Promulgating corporate standards in other areas is far more difficult because the available metrics are not uniform, can be challenging to find, have not been agreed upon by major players, and there is disagreement on what should be measured to create a standard metric.

According to Bloomberg, “…global investors are becoming frustrated with the hodge-podge of standards and ratings designed to guide their allocation decisions and are clamoring for more uniform rules.” [1]

The “S” in ESG measures corporate performance on “Social” metrics, although gaining agreement on what should be measured to create the metrics is difficult. The categories most cited for the social category are gender equality, gender pay equity, ethnic diversity, LBGTQ equality, and a culture of inclusion. Some of these can be measured, such as gender pay equity, but how do you define and quantify a culture of inclusion?

Bloomberg’s Gender-Equality Index (GEI) seems to be the leader in measuring gender equality in corporations, but the corporations self-report, so there isn’t independent verification. You also must pay a fee to join Bloomberg’s Professional Services to review the GEI rating of different companies. [2] (If you have a Bloomberg terminal, you can also review this and several other indices touching on ESG).

That being said, Bloomberg asks for details in many areas of gender equality, all corporations who report their statistics for the gender equity index use a standard framework.  You can find it here. This is a rational start and the type of information portfolio managers need for ESG purposes.

For portfolio managers, the difficulty for us is the list of issues investors want us to consider as part of an overall ESG approach seems to lengthen by the day. Says Bloomberg, “…money managers [are] seeking fewer, more uniform rules and standards for investments tied to environmental, social and governance issues. The subjectivity and complexity of opaque ratings can work against sustainability objectives…” [3]

The best way to become more familiar with what corporations perceive as important components of ESG standards is to look for their ESG reports, which many corporations now issue with their annual reports. As an example, you can find recent ESG reports for Wells Fargo here.

To make certain they satisfy everyone, Wells Fargo lists and reports on fifty categories in their ESG report and gives you so much information that their ESG report is 88 pages long. But what specifically are they doing to reach their goals? That isn’t always apparent. Choosing the best ESG investments for clients is a judgment call by portfolio managers because it isn’t apparent how corporations become “best in show” for ESG besides self-proclamation.

Resources:

[1] https://www.bloomberg.com/news/articles/2021-07-08/patchwork-of-esg-ratings-sow-investor-confusion-as-flows-surge

[2] https://www.bloomberg.com/professional/product/indices/

[3] https://www.bloomberg.com/news/articles/2021-07-08/patchwork-of-esg-ratings-sow-investor-confusion-as-flows-surge

Contributing Writer: Subject Matter Expert Charles McCain

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