ESG metrics criteria are an increasingly popular way for investors to evaluate companies.
Environment, Social, and governance or ESG for short is a factor-based way of evaluating companies or investments’ sustainability rating.
Every company will soon use it to promote their stock is this rating system. Is this good and should you care at all, when you invest? You will get to know the answer to this in the blog further.
WHAT’S IN IT
- WHAT ARE ESG METRICS?
- RELEVANCE OF ESG METRICS
- IDEA BEHIND ESG METRICS
- ADVANTAGE AND DISADVANTAGE OF ESG METRICS
- MSCI ESG METRICS
- ESG METRICS DATASET
WHAT ARE ESG METRICS?
So, the E stands for the environment. At what degree the company’s operations affect the world’s habitats and Natural Resources.
The S stands for social, to what degree the company upholds fair treatment of human capital. How well do they treat their customers, how well do they treat their labor? And then there’s also some diversity factors around the management in the workforce.
So things such as discrimination, consumer protection and human & animal rights are important issues here. So if the company has lawsuits and scandals piling up, they will probably score very low on this one.
The last one G stands for governance, which is the company’s integrity and how a company is run, to uphold integrity and fairness. So, executive vs employee compensation, discrimination, corruption in the board, and other factors like this are contributing factors. So this is about really how pure the intentions are of the management’s, and you can observe that in the way they treat their employees.
RELEVANCE OF ESG METRICS
ESG investing was a big – big trend in 2020 and probably going forwards as well. Sustainability and climate change are very complex topics, and we are not going to discuss them specifically here.
In this blog, we will stick to the actual ESG rating of stocks which is a way to evaluate how sustainable a company is in making its money. It is something investors have become more and more aware of. A lot of significant funds like pension funds or state-run funds and institutional investors and investment companies are forced or have
been started even to consider ESG when they make investments.
So this is the relevance whether you like it or not.
IDEA BEHIND ESG METRICS
Now the system’s idea is to uphold transparency and hold companies responsible for the way they make money by giving them an ESG score.
A high score might help attract new investors, and a low score might scare new investors away and as we know some funds around actually obligates it to follow this rating system.
Now do keep in mind that all rating systems are flawed, just because a company has low easy score does not mean it’s a bad company it does not mean it’s a lousy investment and vice versa if it has a high score it does not mean you should invest in the company. Although this is a pretty decent system, so let’s go ahead and look at what this is all about.
ADVANTAGE AND DISADVANTAGE OF ESG METRICS
When you look at ESG metrics of a company, what you’re looking at is another way of evaluating a company, without looking at its balance sheet, and looking at how it impacts the broader society at large.
A significant advantage of ESG metrics is that they do an excellent job in terms of comparing how well is Company 1 doing compared to Company 2.
But it’s less useful, in looking at what is the overall mission of a company, in terms of, is it out there to do good, and if so, how do you manage that?
Lots of people have different views about its framework. For some people, it’s around environmental is more critical; for some, it’s social, for others, it’s governance. As many people as there are in a room, there are going to be different opinions as to what is essential.
MSCI ESG METRICS
MSCI is the short form for Morgan Stanley Capital International. It is an investment research company that provides portfolio risk and performance analytics, stock indexes, and governance mechanisms to institutional investors and hedge funds.
MSCI ESG Metrics is a tool designed to give institutional investors a broad set of standardised ESG data and simple flagged metrics comparable across an expansive universe of 8,500 companies in the MSCI ACWI Investable Market Index (IMI) coverage universe.
It doesn’t score independently on the environment, social and governance; it just gives a total score. MSCI also evaluates companies on their controversial business activities (weapons, tobacco, gambling, global norms and principles etc.) and sustainable impact solutions (renewable energy, health, education etc.).
The scoring system for ESG metrics usually goes from the MSCI rating, a great one; you can find almost all major companies there. It goes from Triple C to Triple-A. In between, you got B, BB, BBB, A and AA.
A company that is lagging in its industry, based on its high exposure and failure to manage significant ESG risks
A company with an unexceptional track record of managing the most significant ESG risks and opportunities relative to industry peers
A company which is leading its industry in managing the most significant ESG risks and opportunities.
ESG METRICS DATASET
1) Risk Exposure
A new risk exposure dataset leverages MSCI ESG Research’s proprietary ESG risk models, mapping over 50,000 individual business and geographic segments to 22 macro risk factors, such as carbon regulation, water-stressed regions, and corruption risks.
The practices dataset offers insight into a company’s capabilities to manage ESG risks or capitalise market ESG opportunities such as policy commitments, certifications, risk mitigation initiatives, programs, and targets to improve performance.
The performance dataset evaluates the company’s historical track record on managing the specific ESG risk. Performance data involves collecting, standardising, and benchmarking a range of quantitative indicators where applicable.
The controversies dataset offers insights into a company’s involvement in notable environmental, social and governance controversies.
(e.g. lawsuits, disputes, regulatory actions) related to its operations and products, possible breaches of international norms and principles.
So some examples of ratings here ( SOURCE –https://www.msci.com/esg-ratings) :
1) Microsoft scores a triple-A, but it goes laggard on corporate behaviour.
2) Reliance Industries is not a leader on any of the critical issues for its industry.
Reliance Industry Limited is ESG laggard in Corporate Behaviour Toxic Emissions & waste and Health & Safety, Average in Corporate Governance, opportunities in clean technology and Carbon Emissions, ESG Leader in none of the critical issues evaluated for its industry.
3) Mahindra and Mahindra is a laggard in producing opportunities in clean technology.
Alt-text- image showing the sectors in which Mahindra and Mahindra are Laggard, Average and Leader. Mahindra and Mahindra is ESG laggard in clean technology opportunities, Average in Product safety & Quality, Product Carbon Footprint And in labour Management, ESG Leader in Corporate Governance and Corporate Behavior.
So as you can see, a tech company can score a triple-A. Although it’s not producing any renewable energy or making electric cars and a traditional carmaker, an oil company can achieve rating relatively high and although they are perceived as terrible companies.
And so we can think that this goes to show that the system looks at every company on a case-by-case basis. So they don’t just give all oil companies a Triple C and car companies a triple B they look at every company individual. And we know that a company is not wrong just because it produces oil. Producing oil is not a problem in itself or making a car is not a problem in itself, so it’s really how the companies run, not necessarily what industry they’re in.
Now in closing, balance is the most important thing. You should know that when you invest, it’s first and foremost that you should invest in the companies that will produce the highest returns.
That is your primary goal as an investor, but companies showing outstanding sustainability should also lead to better performance over the other company because it is managing its resources better.
So this is not just about finding you know heavy stocks that are green and good for the environment; these are great businesses running well.
Still, either way, do your research, be an individual thinker, a critical thinker be a stock picker and decide where your money is invested don’t just put your money in any stock.
Look at the companies you invest in making sure you know what you’re getting into because you’re giving your money to a company and helping them become more significant.
so ask yourself if that is a company you want to invest in.
That’s our take on the ESG system, and it looks very promising, I was quite surprised by some of the scores I think is good because I thought what every oil company would have a Triple C. Still. I find some that score well, which means they’ve been looking into each company individually.
So, let us hope you find this blog helpful. Let us know what you think of this system in the comment section.
Also you can read our blog on How to manage time wisely – the best way to use dead time wisely