Understanding the characteristics of ESG ratings data

What explains a company’s ESG performance? As investors become increasingly convinced of the financial materiality of environmental, social and governance factors, they are integrating ESG scores and ratings into investment processes and stock selection. But what if the characteristics inherent in those scores mean that they tell only part of the story? What if they are unfairly penalizing some best-in-class companies, and elevating more run-of-the-mill ESG performers?

ESG practitioners have recognized for some time that ESG scoring approaches have a number of inherent biases. Large companies tend to get better scores than small-caps. Developed market companies outperform their emerging market peers. Some sectors systematically fare better than others.

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