A surge in interest in sustainability programs and sustainable investing has resulted in a “rapidly multiplying” number of ESG ratings systems, according to Dimensional Fund Advisors, with little governance around the veracity of these systems leading to a decline in quality.
Advisers and investors should be wary of them, says Dimensional’s head of responsible investment Joseph Chi. Many of the ratings providers base their ratings largely on subjective opinions, he believes, and most have their own way of approaching the sector.
“Given the subjectivity inherent in ESG ratings, we believe they should be viewed not as objective ratings but as opinions,” Chi says in a recently published report ESG Data, Ratings, and Investor Objectives.
“ESG ratings have grown in popularity as an option for investors to outsource company or portfolio analysis on ESG measures,” Chi says, noting that of the 250 global companies by revenue, 96 per cent published sustainability reports in 2020 – triple that of 1999.
“The subjectivity, complexity, and opacity of ESG ratings may limit their usefulness to investors, however, and lead to unexpected outcomes.”
The spectre of ‘greenwashing’ – whereby marketing is used to convince consumers that companies are more environmentally friendly than they are – is significant enough now that the European Securities and Markets Authority (ESMA) to lament that the market is ‘unregulated and unsupervised” in a submission to the European Commission.
“When combined with increasing regulatory demands for consideration of ESG information, there are increased risks of greenwashing, capital misallocation, and products mis-selling,” ESMA stated.
According to Chi, investors would be better served doing their own research. “A better approach is for investors to determine their specific ESG priorities, identify relevant data, and integrate these data into a sound investment approach,” he says.
*Renato Mota will be speaking at the Professional Planner Licensee Summit in Katoomba next week, June 7 and 8.