ESG efforts are important, and businesses that get it right enjoy benefits such as attracting investors, improved financial performance, customer loyalty, and competitive advantage.
To measure how well organizations are executing their ESG goals, the ESG rating comes in handy. An organization’s score will comprise ESG metrics that promote environmental sustainability, business ethics, human resource practices, and governance concerns. Investors can use these scores to assess the opportunities and risks in a company and areas of improvement.
Read on for what investors need to know about ESG scores.
How ESG Scores Work
Governments and stock markets require management teams to disclose ESG in their reporting. For clear and relevant metrics, a company will select a reporting framework.
The rating agencies and stakeholders interested in ESG scores often review the company disclosures, conduct management interviews and compare the metrics with that of other companies, presenting a score for the company. As such, ESG raters bridge the gap between the general public interpretation and the organization’s disclosures. Through ESG ratings, investors can find suitable investors.
Potential ESG Rating Limitations
ESG rating agencies regulate the scores, and no government oversees this administration. Agencies like Sustainalytics and MSCI simplify the work of investors by revealing which companies are scoring well on their websites. Still, some companies paint a different picture. Given the minimal standardization and regulation around ESG scores, there are bound to be variations as there is no clear guidance on the issues to take precedence. Therefore, an investor should know that ESG scores can have other goals, and some scores do not necessarily mean a positive impact.
There is a risk of greenwashing on the environmental factors, where organizations claim to influence an aspect without material impact. There is also a need for more transparency in calculating and weighing the ESG ratings, as only a few firms offer a full view of their calculations. Lastly, given the broadness of ESG across environmental, social, and governance issues, a rating may be incomprehensive to complete an ESG picture.
How ESG Ratings Affect Investors
Generally, there is a demand for ESG investment to mitigate risks and make the world a better place. ESG ratings give a uniform way for investors to align their investment activities with their goals. Despite the shortcomings in the scoring systems, socially conscious investors can use their power when they can understand the scores and are convinced of their establishment on sound research. Some of the ways investors benefit from ESG ratings include:
- ESG ratings supplement financial analysis and give insights into a company’s risks.
- ESG ratings are a screen for reviewing the scores of a company to rule out companies that are unideal candidates for your portfolio.
- ESG ratings offer insights into a company you know, with negative changes flagging your attention to discover why.
ESG Scores Guide Ethical Investments
ESG ratings are essential in weighing a company’s risks and investments. However, these ratings should not be the final word in making an investment decision. With each rating agency’s scoring methodology, an investor should understand the ratings and select a platform with better ESG scores.