As environmental, social and governance (ESG) strategies gain in popularity, investors need a better understanding of the methodology behind ESG ratings, according to Impax Asset Management.
In a note to clients, Impax said a number of financial information providers now rate the overall sustainability of investment funds.
However, the methodology used by the various ratings providers differs – “We have noticed some important differences in the underlying methodologies of these rating providers in the emphasis that they place on various aspects of the investment process,” Impax said.
The firm indicated that by focusing on certain aspects of companies’ activities, such as operational aspects, some of the ratings may be “misleading to investors looking for long-term sustainable investments".
Moreover, Impax said investors need to be aware of the company size and geography of fund holdings. The asset manager noted that larger companies have more developed ESG-disclosures and European countries are more developed in their reporting practices than US or Asian companies.
“The company size and geographic allocations of a fund may therefore significantly skew the ESG rating results,” Impax said.
Larger companies can afford to submit the data required by ESG ratings providers, whereas smaller companies may struggle to do so and subsequently receive a lower ES rating.
“We would therefore caution against the direct comparison of funds with such different investment approaches, as other factors than actual sustainability and ESG quality may drive the ratings,” Impax said.