ESG integration: relying on third party scores
Environmental, social, and governance integration most often uses tools or data sets of what are called ESG scores or ratings, which tend to share the following common characteristics:
- ESG ratings are typically calculated by third party agencies.
- They are largely based on companies’ sustainability disclosures. Generally, the more information a company publicly discloses, the higher the ESG score it can earn.
- ESG scores tend to most often be business model agnostic, meaning that a coal mining company can still earn the highest possible score so long that it has proper policies in place. And vice versa, a renewable energy company that has a business model which actively transitions the energy systems away from fossil fuels but does not have strong policies in place – it would still likely thereby earn a low ESG score.
Asset managers often use these scores to quickly assess how well companies are run. They can be used in valuation models to identify mispricing or risks -- and they can enable simple comparative analyses across sectors, regions, or industries. Typical ESG investing styles apply these scores to major benchmarks/indices as screening and/or reweighting criteria.