HONG KONG SAR –\u00a0Media
It is not uncommon for the ratings of different ESG rating
\u00a0<\/p>\n Sustainable investing, also known as
\u00a0<\/p>\n Perhaps due to its relatively recent
\u00a0<\/p>\n The new study Sustainable Investing with ESG Rating Uncertainty<\/a> was co-conducted by Si
\u00a0<\/p>\n In their study, Prof. Cheng and her
\u00a0<\/p>\n Ratings Disagreement<\/b><\/p>\n “Generally, because there’s a
\u00a0<\/p>\n Using data from the six ESG rating providers,
\u00a0<\/p>\n Using these scores, the researchers
\u00a0<\/p>\n The study found that institutions
\u00a0<\/p>\n In contrast, hedge funds invest more
\u00a0<\/p>\n And while companies which focus on
\u00a0<\/p>\n Market Implications<\/b><\/p>\n Lastly, the study implies that
\u00a0<\/p>\n Green stocks are harmed the most
\u00a0<\/p>\n “In the face of uncertainty
\u00a0<\/p>\n Overall, the study results have significant
\u00a0<\/p>\n “Sustainable investing is on
\u00a0<\/p>\n Reference:<\/b><\/p>\n Avramov, Doron and Cheng, Si and Lioui, Abraham and
\u00a0<\/p>\n This article was first published in the China
\nOutReach<\/a>\u00a0– 24 September 2021 –\u00a0Sustainable investing, once viewed as an outlier maybe only
\na decade ago, has never been more popular. To put things into perspective,
\nsustainable funds in the U.S. attracted record investment of nearly US$2
\ntrillion in the first quarter of 2021, according to industry data provider Morningstar<\/a>.
\nAs demand for ESG (environmental, social and governance) investing grows, so
\ndoes the need for better quality ESG performance data. However, a recent
\nresearch study has found that ESG ratings of firms provided by different
\nagencies can be confusing to investors and may be holding back the sustainable
\ninvestment sector from realising its full potential.<\/p>\n![](\"https:\/\/images.media-outreach.com\/Thumb\/500x0\/179424\/CUHK.jpg#image-179424\")
<\/p>\n
\nproviders to be widely dissimilar. For example, Tesla Inc. is rated average by
\nMSCI ESG ratings but categorised as high risk by Sustainalytics. (source:
\niStock)<\/i><\/p>\n
\nESG investing or socially responsible investing, is an approach that asks
\ninvestors to consider a company’s ESG profile alongside its financials when
\nmaking an investment decision. Such additional factors include everything from
\na company’s energy use, waste and pollution, to its working conditions,
\nparticipation in its community and diversity in its board of directors. Because
\nof these considerations, it is not unusual for sustainability-minded investors
\nto set maximum thresholds or even shy away altogether from less “ethical”
\nsectors such as coal, defence, gaming or tobacco.<\/p>\n
\narrival in the finance world \u2013 the term ESG investing itself was first coined
\nby the U.N. Global Compact<\/a> as
\npart of a landmark 2004 study titled Who Cares Wins<\/i><\/a>, there is no universal standard nor a commonly accepted
\nmethodology for calculating ESG ratings among different agencies. According to KPMG<\/a>, there are
\naround 30 major ESG data providers worldwide in 2020. These rating agencies
\nusually adopt different measurements when constructing their ESG scores. It is
\nnot uncommon for them to provide different ESG ratings for the same company.
\nFor example, Tesla Inc. is rated average<\/a> by MSCI ESG
\nratings but categorised as high risk<\/a> by
\nSustainalytics.<\/p>\n
\nCheng<\/a>, Assistant Professor in the
\nDepartment of Finance at The Chinese University of Hong Kong (CUHK) Business
\nSchool, Prof. Doron Avramov at IDC Herzliya, Prof. Abraham Lioui at EDHEC
\nBusiness School and Prof. Andrea Tarelli at the Catholic University of Milan.<\/p>\n
\nco-authors tested their hypothesis using U.S. stocks from 2002 to 2019 and
\nexamined the ratings from six major ESG rating providers \u2013 Asset4<\/a> (Refinitiv), MSCI
\nKLD<\/a>, MSCI IVA<\/a>, Bloomberg<\/a>, Sustainalytics<\/a> and RobecoSAM<\/a>.
\nIn line with existing studies on ESG ratings, the research team also found
\nconsiderable disparity across different ESG rating providers. They found that
\nthe confusion in the different ratings provided by the ESG rating agencies made
\nsustainable investing riskier and decreased investor demand for stocks.<\/p>\n
\nlack of consensus in reporting, measuring and interpreting ESG information,
\nthere’s a lot of ESG data out there on firms and these can both be overwhelming
\nand perplexing. That’s why it can be difficult for investors to ferret out the ‘true
\ncolour’ of a firm, whether that be, green, brown, or something in between,”
\nProf. Cheng says. “That in turn feeds back into investor appetite in
\nsustainable investment. If an investor is looking for ESG plays and they’re not
\nclear about the sustainability of the stock they’re about to sink money into,
\nthen they obviously are going to think twice before proceeding.”<\/p>\n
\nthe researchers generated an ESG score for each stock, as well as a score to
\nmeasure the difference in the ESG scores between the six agencies in order to
\ncalculate the level of uncertainty in ESG ratings. According to the results,
\nthe average rating correlation is only 0.48, and the average ESG rating
\nuncertainty is 0.18. For perspective, this means that a company could be ranked
\nin the bottom third by one data provider but be ranked in the 59th percentile
\nby another.<\/p>\n
\nlooked at how inconsistency in ESG ratings affected whether an institutional
\nowner would invest in a particular stock, and the impact on the stock’s actual
\nperformance on the market. The study considered three distinct types of
\ninvestors. The first type are organisations such as pension funds as well as
\nuniversity and foundation endowments, which constrain their investments to
\nsocially acceptable norms (such as by engaging in socially responsible
\ninvesting) when compared with other institutional investors which are more
\ninterested in generating financial returns, such as hedge funds.<\/p>\n
\nwhich were more constrained by investment norms were indeed in favour of
\ngreener firms, but were less likely to hold green stocks when there is a high
\nlevel of inconsistency over ESG ratings. For companies with the highest ESG
\nscores, norm-constrained institutions on average hold 22.8 percent of their
\nshares, but only when the ratings put out by the different ESG agencies were in
\nhigh agreement. When the correlation in ESG ratings between the different
\nratings agencies were low, institutional ownership level dropped to 18.1
\npercent.<\/p>\n
\nin brown stocks on average, and rating uncertainty mostly affects their
\nholdings for brown stocks. For companies with the lowest ESG scores in the
\nstudy, the researchers found that hedge funds owned an average of 15.7 percent
\nof shares when there was high agreement between the ESG scores from different
\nratings agencies. This again dropped to 13 percent when the correlation in the
\nratings from different agencies diverged. The authors conclude that rating
\nuncertainty matters the most for investors in their preferred investment
\nuniverse.<\/p>\n
\nimproving their ESG performance are expected to deliver lower investment
\nreturns because they provide nonpecuniary benefits to investors, the study
\nfound that this was not always the case. Specifically, it found that brown
\nstocks always outperform green stocks only when ESG ratings ambivalence is low.
\nWhen there is a high level of agreement between the ratings of different ESG
\nrating agencies, brown stocks surpass green stocks by 0.59 percent per month in
\nabsolute returns and 0.40 percent per month in risk-adjusted returns. But when
\ninconsistency between ESG ratings rises, there is no clear relation between a
\ncompany’s ESG leanings and their stock performance.<\/p>\n
\nambiguity in ESG ratings has an overall impact on the entire stock market. In
\nparticular, a higher level of ratings confusion is linked with higher market
\npremium, as well as lower stock market participation and lower economic welfare
\nfor ESG-sensitive investors.<\/p>\n
\nwhen ESG rating confusion is high. Firms which take a more responsible path in
\ntheir operations are disproportionately penalized if ratings agencies fail to
\nagree on their ESG profile. This in turn would further limit their ability to
\nmake capital investment and generate a real social impact.<\/p>\n
\nover a company’s ESG profile, ESG-sensitive investors are just as likely to
\nstop making ESG investments or engage in corporate ESG matters,” Prof.
\nCheng adds.<\/p>\n
\nimplications for asset allocation, investor welfare, and asset pricing. In
\norder to minimise the downside brought to ESG investing by rating
\ninconsistency, Prof. Cheng and her co-authors suggest companies disclose more
\ncandid reports on their ESG performance. For ESG rating providers, the
\nresearchers advise them to further release and explain their measurement
\npractices and methodologies. Furthermore, they argue that more public
\ndiscussion on how to measure ESG performance of companies should help to
\nelevate the quality of ESG ratings.<\/p>\n
\nthe rise. Therefore, the overall impact of ESG rating inconsistency will become
\neven more prominent,” Prof. Cheng says.<\/p>\n
\nTarelli, Andrea, Sustainable Investing with ESG Rating Uncertainty (July 26,
\n2021). Available at SSRN: https:\/\/ssrn.com\/abstract=3711218<\/a> or https:\/\/dx.doi.org\/10.2139\/ssrn.3711218<\/a><\/p>\n
\nBusiness Knowledge (CBK) website by CUHK Business School: https:\/\/bit.ly\/3kq2Y12<\/a>.<\/p>\n