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ESG in Practice: Costly Expense Driver or Sustainable Channelling of Capital?

© Joachim Löning

Our last publication on ESG investing focused on the subjective returns associated with sustainable investing. Because there is a strong demand for this return among end clients, the investment industry puts considerable effort into the launch, management and sale of sustainable investment products. To make the right decisions, the industry uses ESG ratings of investable companies.

Methodological Problems with ESG Ratings

Comparing the ESG ratings of the providers with each other, only low correlations are found between the respective offers. This methodological problem may be caused by subjective differences in the assessment of the key issues and in the weighting of the data. A strong past orientation or greenwashing on the part of the companies studied could also play a role. In any case, the low correlation of ESG ratings deserves a closer look.

Some of the methodological challenges that the regulator expects the industry to address are solvable or likely to be addressed by the EU taxonomy, such as harmonising the criteria for whether and to what degree economic activities can be considered sustainable. In this context, the still considerable costs for the established ratings point back to the providers, whose sovereignty of interpretation and business model are threatened by the progressive standardisation of the data basis.

At the same time, the market for sustainable investments is open to alternative approaches and data sources. In a recent approach by Dr Andreas Beck (see interview), for example, patent databases are propagated as an alternative data source for sustainable investment decisions. Other providers read online available news sources and publications of companies (screen scraping) and use automated methods of text analysis to create ratings.

Biased Investment Decisions?

As there are only a few ratings available on the market, even small differences in the assessment of companies with regard to their environmental behaviour, social factors and factors of good corporate governance can lead to different investment decisions, thus channelling the capital differently, although the investor always wants the same thing.

The low correlations between different ESG ratings cast considerable doubt on the validity of the ratings, but also underline the complexity and multi-faceted nature of sustainable investment. Another facet is that although all rating providers now also refer to the SDGs of the United Nations, the interpretation of their implementation again differs considerably.

Many banks and investment managers have recognised the problem and use additional, proprietary procedures for the selection of ESG investments. Therefore, in practice, tetralog’s consulting tools use ESG data from different providers to use them for new types of visualisations and optimisation approaches and to meet regulatory requirements.

Doing Good with Your Investment

Doing good with investments is a fantastic opportunity to charge the abstract topic of investments with positive emotion. However, if the informative value of available data does not improve, end customers could become unsettled by the resulting damage to their image and approach the “sustainable” channelling of their capital with increasing scepticism.

Alternative rating procedures should in any case be viewed positively because they can provide more certainty and thus represent an opportunity for external validation. In any case, we would be happy to support you with our ESG advisory solutions. There is still a lot to do!

Yours, Lothar Jonitz
Munich, 07 Dec 2022 | Last revised: 20 Dec 2022

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