ESG scoring could help you identify how to invest in a way that aligns with your values. However, it’s not always clear which option might suit your needs, as different systems can rank the same investment very differently.

ESG investing means considering environmental, social, and governance factors when making investment decisions. For example, how a company treats its employees, its transparency, or its carbon emissions might influence whether you want to invest.

Ratings aim to summarise a company’s performance across ESG categories, providing valuable information to investors.

A methodology is followed to create an ESG rating

The process of assigning an ESG rating to investments will typically start with gathering data.

Data gathering might mean reviewing information that companies provide, such as annual reports or corporate sustainability reports. This will often be supplemented by information from third parties, such as industry reports, and the media, like news articles and legal cases.

Once the information has been gathered, the organisation providing the rating will follow a set methodology, which will vary between providers.

They may follow a set process for combining quantitative and qualitative inputs and assign importance to different ESG factors. Some ratings might also adjust the process for different industries. For example, the ESG factors with the greatest importance differ between the technology industry and the retail sector.

Finally, the companies or investment fund will be scored and ranked. As a result, investors may quickly see how investment opportunities compare with others.

However, as rating systems don’t follow the same methodology, the outcome may vary significantly.

Why the same company might receive two very different ratings

As the methodology for ESG scoring is complex, and there are multiple ways it’s approached, it’s not surprising that ratings diverge.

One rating might focus on financial risk, such as whether a company is exposed to regulatory penalties or reputational damage, while another may place greater weight on real-world impact, such as carbon emissions and social outcomes.

So, the same company could receive a very different rating depending on the methodology used.

In addition, not all companies disclose the same level of detail. As a result, there might be gaps in the information, which rating methodologies may approach differently. Some will use industry averages to fill in the gaps, while others might model assumptions, which could lead to varied results.

How a ratings agency handles negative events could also significantly affect the outcome.

Imagine an environmental spill threatens water supplies. One rating agency might penalise the company heavily and immediately for this. A different rating agency might choose to wait until an investigation has been carried out to assess the cause first.

As a result, it’s not uncommon for one company to be rated highly by a rating agency but receive a moderate or even poor rating from a different one.

How ESG scoring is presented also varies. For example, MSCI gives a letter rating based on how well companies manage risk and opportunities relative to peers and places them into three categories – leader, average, or laggard. In contrast, FTSE Russell’s ESG ratings use a 0 to 5 scale.

These discrepancies don’t mean that one rating is “wrong”. Instead, it highlights how ESG factors and their importance are often subjective.

Using ESG scores as an investor

So, while ESG scoring may be useful for investors who want to incorporate ESG factors into their decisions, it might not be as straightforward as it first appears.

A good place to start is by setting out your personal values – what factors are important to you and might influence how you decide to invest your money?

From here, you can then review the different methodologies rating agencies use to understand which most closely aligns with your values, or identify the areas you don’t agree with. You might also compare different scores to highlight areas you want to pay closer attention to, or look beyond the headline score to better understand why the rating has been given.

Working with a financial planner could help you assess different ratings and understand how an investment might fit into your portfolio, including how it aligns with your values.

Remember, your investment decisions should not be based solely on an ESG score. It remains important to consider your personal circumstances, investment goals, and what level of risk is appropriate for you.

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We could help you review your current investment portfolio and goals, including assessing how you incorporate ESG factors. Please get in touch to arrange a meeting.

Please note:

This article is for general information only and does not constitute advice. The information is aimed at individuals only.

All information is correct at the time of writing and is subject to change in the future.

The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.

Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.