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OVERVIEW
The sustainable investing approach considers environmental, social, and governance (ESG) factors in portfolio construction and management. Once the domain only of socially responsible investors trying to exclude sustainability laggards from their portfolios, sustainability investing no longer is characterized as a niche approach. At the beginning of 2018, the assets under management using sustainable investing strategies1 surpassed US$30.7 trillion (or around 9% of global debt and equity) in the five major markets of Europe, the US, Canada, Japan, and Australia and New Zealand (Global Sustainable Investment Alliance 2018). In the 2 years leading up to 2020, professionally managed funds adopting sustainable investing strategies in the US alone increased by 42% to US$17.1 trillion (US SIF 2020). The inflows to ESG investing funds continued to grow in 2020, achieving by the middle of the year the full-year amount for 20192 (Hale 2020). A 2019 survey of more than 550 CFA Institute members worldwide shows that more than half of the quantitative analysts or portfolio managers incorporate environmental and social factors into their investment analysis, and two-thirds factor in governance (Singh and Peters 2019).
The rise in sustainable investing has created a new industry that trades in ESG data and ratings on companies, funds dedicated to rated companies, and ESG index providers. Hawley (2017) notes more than 600 products from over 150 organizations that supply ESG data, ratings, and rankings; MSCI Inc. and Sustainalytics are the leading players. The industry is dynamic, with new ratings appearing and disappearing while rating organizations merge and realign at a rapid pace (Sadowski, Whitaker, and Buckingham 2010a). Academics, for instance, use ESG ratings to understand how the financial performance and market performance of sustainable companies differ from those of other firms—and what drives those differences. ESG ratings as well as academic research based on them can potentially influence regulators, impacting policies and regulations related to the disclosure and use of ESG data.3 The unquestioning reliance on ESG ratings by various parties—including investors, academics, and regulators—makes it important to understand whether ESG ratings reflect the true ESG performance of companies and whether different ESG ratings converge. The purpose of this article is to identify the causes of the differences in the ratings and rankings produced by different agencies.
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