While a score-based approach to environmental, social and governance (ESG) serves the interest of ratings providers, it is not always a useful guide for investors and could lead to increased risk.
According to Scientific Beta, in its paper ‘Scoring against ESG? Avoiding the pitfalls of ESG scores in portfolio construction’, scoring was not found to guide investors on ESG investing. There were numerous different types of scoring, definitions and data available which created inconsistences and led to subjective assessments being made.
This echoed previous criticism by the OECD who said ESG scores should not be viewed as a meaningful indicator of a strategy’s ESG goals.
It was particularly the case when it came to the environmental and the fight against climate change and the rise in greenwashing.
There were also concerns linked to averaging ESG scores across a portfolio and using such an average as a goal or constraint in portfolio construction as portfolio optimisation based on averages could magnify the estimation of individual ESG scores.
The organisation said: “Average ESG scores provide useful insights only if one assumes that scores very accurately proxy for ESG risks and furthermore that these risks are linear. None of these assumptions are substantiated by academic studies, or even by intuition or casual observation. Ultimately, the use of these global scores leads to increased investment risks”.