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Why ESG scores don’t tell the whole story

By Richard Butters
 — 1 minute read

The market now views ESG as an enhancer of returns, but not all ESG metrics are created equal, writes Aviva Investors’ Richard Butters.

Some ESG metrics are top-level summary ratings, while others are topic specific. Furthermore, each ratings provider uses a different methodology, which results in a low correlation between ratings that supposedly measure the same thing. 

Compared with traditional financial reporting, ESG disclosure is not as deep, nor is it consistent between companies. Financial statements often only provide 20 to 30 per cent of the ESG metrics investors may want to track for an industry. Nevertheless, the quality and availability of data are improving, with companies including metrics, targets, descriptions of progress and KPIs. Encouragingly, ESG reporting standards are beginning to converge, which should provide greater clarity for investors.


Using an external score helps research teams develop a deeper understanding of the methodology and its limitations. ESG ratings do not always impact a credit rating directly, but understanding ESG risks and opportunities helps credit analysts form a holistic view. For example, if a business has a relatively high exposure to carbon and a carbon tax is announced, the impact on its earnings and balance sheet can be assessed quite precisely.

Some risks are more qualitative and difficult to estimate. For instance, the effects of a controversy in a company’s supply chain can range from managing brand damage to undergoing a program of policy, audit and practice reviews, entailing significant costs.

Another important aspect is the ability to look at the momentum of a company’s ESG practices, in contrast with the backward-looking snapshots external scores provide. When an ESG analyst assesses a company, they will assign a point-in-time opinion (positive, neutral or negative) and a trend opinion (improving, stable or deteriorating). Some may incorporate a rate-of-change perspective. This allows portfolio managers to not only hold strong ESG performers, but also those with a strong improving trend.

Meeting with company management teams also provides critical insight. When asking management about environmental practices and related compensation, for instance, if the response is hesitation and platitudes, that possibly indicates a lack of commitment. Conversely, if they discuss KPIs and how they feed into compensation, that gives investors more confidence and can be fed into analysis. 

Probing where ESG views differ between scoring systems can also be useful. Fast fashion company Boohoo offers a striking example. Although our proprietary ESG score for the company was positive – demonstrating analysts can only get so far with metrics-based analysis – it also showed the firm was in the middle of the range versus peers than MSCI’s ESG ratings, which placed Boohoo at the higher end. Our engagement with Boohoo’s management team also revealed significant governance issues, an assessment that was shared with the investment teams. 

Volkswagen is an opposite example. While its 2015 emissions scandal would have been impossible to predict even with regular engagement, what has happened since is interesting. Its bond prices recovered quickly, and within 12 months fines and settlements were mostly agreed. Additionally, although there are still governance issues, research and engagement have shown that the company underwent a significant transformation, from the strategy – whereby electric vehicles (EV) replaced diesel as a focus – to culture.

MSCI’s ESG rating for Volkswagen, however, has remained CCC, despite changes at the company. This is driven by news flow, whereby MSCI notches Volkswagen’s ESG score down every time there is news of a fine or settlement. This is unfair, as the score should recognise the company’s transformation, improving financials and ESG credentials, and the likelihood this will continue.

Thus, assessing ESG credentials is more complex than simply avoiding companies with poor scores. For active managers that take stewardship and engagement seriously, there is some rationale in having exposure to underperformers, where they can use their influence to improve ESG practices. Furthermore, mainstream portfolios have targets to beat their benchmark, which requires managers to be pragmatic and balance ESG risks with return opportunities.

Richard Butters, ESG analyst, Aviva Investors

Why ESG scores don’t tell the whole story

The market now views ESG as an enhancer of returns, but not all ESG metrics are created equal, writes Aviva Investors’ Richard Butters.

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