The prevalent belief is that a company’s commitment to the environment, social and governance (ESG) is the foundational step towards a green transition. Yet, recent research shows that ESG ratings might not be a reliable measure of a firm’s sustainability. Diving deep into ESG without adequate planning can divert companies off their intended paths, using up crucial resources on ineffective tactics. Far from simplifying the green transition, an overemphasis on ESG might muddle it, overshadowing the significant contributions of each stakeholder. Actual green transformations emerge when leadership and teams collaborate with insight and awareness.
ESG Scores and Carbon Intensity: A Revealing Mismatch
A recent study disclosed an intriguing fact: a company’s ESG score isn’t a guaranteed indicator of its carbon footprint. Contrary to what one might assume, top-rated ESG firms can have similar pollution levels to their low-rated counterparts.
Diving Deeper: ESG vs. Carbon Output
Scientific Beta, an expert consultancy, has identified a significant disconnect between ESG scores and a company’s carbon output relative to its revenue or market value. Felix Goltz, their research director, emphasised that ESG scores, even when narrowed down to environmental factors, scarcely relate to carbon output.
Moreover, Goltz suggests that ESG goals might counteract efforts to lower carbon output in eco-friendly portfolios, especially as ESG investments gain traction, drawing an impressive $49bn in just the first half of this year.
Research Breakdown
In an analysis spanning 25 different ESG ratings from leading providers like Moody’s, MSCI, and Refinitiv, startling findings emerged:
- Factoring ESG scores can erode up to 92% reduction in carbon output, which could be achieved by exclusively stock-weighting based on carbon output.
- Focusing only on environmental factors of ESG can significantly compromise green credentials.
- Combining social or governance factors with carbon output often results in less green portfolios than traditional ones.
The crux? A paltry 4% correlation between ESG ratings and carbon output underscores the divergence in their respective objectives.
Decoding ESG Scores
Keeran Beeharee from Moody’s pointed out that ESG ratings, being holistic, encapsulate multiple variables. Hence, tying them strictly to metrics like carbon output becomes intricate. With global initiatives like the UN’s sustainable goals and the Paris Agreement, the boundaries of ESG about climate parameters became evident. Now, tools specialised for carbon output measurement are in play.
MSCI ESG Research and Refinitiv both emphasise that their ESG evaluations prioritise company resilience over direct climate impact, making a weak tie between ESG ratings and carbon output unsurprising.
A Call to Investor Awareness
While not startling, Hortense Bioy of Morningstar suggests that the study underscores the vital decisions in sustainable investing. Investors must decide their emphasis: carbon reduction or ESG prominence.
Goltz warns of the evolving and expanding ESG criteria. Incorporating new dimensions, like biodiversity, might cause a diffusion in the core focus. True carbon reduction in portfolios demands undivided attention to carbon output.
In essence, the study prompts a reevaluation of ESG’s universal appeal. As the ESG horizon widens, investors must refine their sustainability benchmarks.