Should you trust ratings agencies?

So, who are these rating agencies?

The largest are MSCI ESG, FTSE Russell’s ESG Ratings, Sustainalytics (partly owned by Morningstar) and RobecoSam (recently acquired by S&P). There are also many smaller players, suggesting consolidation will eventually take place.

What do they do?

These firms score companies based on internal ESG parameters. Data collection is tedious, requires frequent updates, and is ultimately an exercise to try to fit data into the internal boxes each of the rating agencies has.

Where do they source the information from?

Information is sourced by rating agency analysts from what is publicly available. This leads to data quality challenges, as reporting from a $100bn developed market business will be very different than from a $1bn EM business.

Why do they exist?

To profit from a growing business need from the rapidly growing ESG asset class.

Our three key concerns are: 

1. Data credibility

Through our own review of portfolio companies in relation to rating agency datasets, we have seen wrong or outdated data bringing down scores, as well as subsequent inaction from agencies on correcting wrong data.

2. Irrelevancy of data

For example, the direct carbon emissions/footprint of a bank is important but nowhere near as important as whether that bank is funding coal projects or projects that do not adhere to minimum environmental standards. However, most rating agencies we have interacted with do not seem to have the resources to analyse – in depth – or factor in these unusual, yet highly relevant, metrics.

3. Comparing apples and pears

We therefore encourage clients to perform extensive due diligence on the investment manager that they are considering entrusting their capital with, to be comfortable that the product truly follows the ESG strategy that its label suggests.

Let’s take Tesla as an example. Clearly electric cars are a complex beast; they eliminate roadside pollution, but raise questions in relation to the supply chain of some of the components as well as on the sources for the electricity that power them. In the US and Germany, around 80% of the overall energy production is from fossil fuels, so it could be argued that these fossil fuels are ultimately what power electric cars. There are also significant issues around battery sourcing and disposal. Below is an illustration of the issues we see. We would especially like to emphasize the environmental performance and how different it looks across the different agencies, highlighting the issues we raised earlier.

Conclusion