ESG Scores: Correlations Between Providers

Two weeks ago, we looked at Facebook which is included in many ESG-themed indices and funds despite corporate governance concerns and a recent data privacy scandal. Some ESG managers even divested from FB following the scandal. Although Facebook is the most recent example, there are divergent views and competing opinions regarding the ESG characteristics of many companies.

A quick glance at some of the largest ESG funds reveals that there is a range of opinions regarding many companies, from JP Morgan to Exxon Mobil to Netflix. Some ESG funds own these names and some do not. We can see this visually by pulling ESG ratings from two different providers for companies in the S&P 500 index. The results (below) are all over the place with a weak correlation. Upon first glance, it appears that ESG factors (like other investment factors, such as quality or value) are in the eye of the beholder.

source: Bloomberg

However, things look much different at the fund level. Below are the respective ESG scores from two large ESG ratings firms for some of the largest large-cap ESG index ETFs. The correlation is much higher and the scatterplot falls within a much tighter range (blue lines). Sure, there are differences in methodology, holdings, and weights, but the aggregate ESG ratings are similar.

source: Bloomberg

This is similar to relationships that we find in the traditional investment world. For instance, value funds weighted by P/E, P/B, P/CF, dividends, CAPE, and so on, may all have different holdings and weights, but they largely share similar characteristics and factor tilts.

Just as investors should not get too hung up on the high level numerical ESG scores or use subjective judgments arbitrarily, it does help to understand the inputs, assumptions, and overall methodology of the ESG ratings. The ESG ratings of individual companies can vary wildly, but a larger portfolio (such as a mutual fund or an exchange-traded fund) will diversify a lot of that variability away (as shown above). However, funds are constructed in a variety of ways and there are both better and worse ESG funds out there, so investors still need to look under the hood to know what they own.

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