Welcome to the very first GSI Podcast from Global Systematic Investors, presented by financial journalist and author Robin Powell.
In this episode we’re going to look at ESG ratings. What exactly are they? How do ratings agencies form conclusions? And, how reliable are those conclusions from the investor’s point of view?
Hello and welcome to the first GSI podcast. I’m Robin Powell. GSI stands for Global Systematic Investors. The company’s mission is to provide a successful long-term investment experience whilst allocating more to companies with a sustainable vision. To find out more, just visit the website, GSIllp.com. That’s GSIllp.com.
In this episode we’re going to look at ESG ratings. What exactly are they? How do ratings agencies form conclusions? And, how reliable are those conclusions from the investor’s point of view?
Our guest is Eoghan Gill from Sustainalytics, one of the biggest and most highly respected ESG ratings agencies. If there’s a specific subject, you’d like to hear Eoghan talk about, here’s a breakdown of the interview, including time codes, so you can skip straight to the answer you’re looking for.
Here is my interview with Eoghan Gill, from Sustainalytics:
1.32 – Robin Powell | Host: So Eoghan tell me what is your position at Sustainalytics?
Eoghan Gill | Sustainalytics: I am an Associate Director with in Sustainalytics and I work in the client relations team – meaning I work day to day with institutional investors has they seek to integrate ESG, data and research into their investment making decision process.
1.55 – Robin Powell | Host: For people who are unfamiliar with this area of the financial services industry, you are effectively an ESG Ratings agency.
Eoghan Gill | Sustainalytics: Exactly.
2.15 – Robin Powell | Host: What exactly is an ESG ratings agency?
Eoghan Gill | Sustainalytics: An ESG industry ratings agency is an organisation that essentially assesses companies on their non-financial metrics. Non-financial metrics are those beyond the usual PE ratio or return on capital etc., and they’re very much focused on environmental, social and governance issues. One of the questions we get as well from investors is, ‘What exactly is ESG?’ I think at the minute ESG can cover a really wide range of topics, so that can be looking at things like product involvement or revenue derived from companies who produce alcohol or tobacco or weapons, or also other things such as palm oil. But it’s also looking at things like the impact on the climate whenever it comes to particular investments, or the flagship ESG ratings that have become very popular over the past few years. It’s our job and our responsibility as an agency to compile that research, analyse it, assess it, and then pass it on to investors for them to integrate into their processes.
3.52 – Robin Powell | Host: How many different agencies are there? Who are the major players?
Eoghan Gill | Sustainalytics: There has been a real boom within ESG, especially over the past couple of years. So, there are quite a lot of ESG ratings agencies now. They’re all doing different things and they’re all fulfilling different needs of investors. But the more traditional players would be the likes of Sustainalytics. But you’ve also got the likes of MSCI in there, you’ve got Moody’s, who have all been doing this for quite some time. We’ve been doing this since 1992, so well before ESG as a term was ever created or before ESG was in vogue.
4.59 – Robin Powell | Host: Who are Sustainalytics and in what ways do you differ from the other major agencies?
Eoghan Gill | Sustainalytics: Morningstar fully acquired us in the summer of 2020, and so we’re sitting within the Morningstar group now. What makes us different? Well, I think because we have been doing this since 1992, we’re a values and mission-driven business. Everybody who I work alongside — and I have well over a thousand colleagues within Sustainalytics — is doing it because they believe in the correct allocation of capital, in order to make a more sustainable or a more just world for investors to get involved with.
5.55 – Robin Powell | Host: Can you give an overview of Sustainalytics’ approach to ESG risk ratings?
Eoghan Gill | Sustainalytics: Our approach to ESG ratings? OK, I’ll try not to get into too many of the technicalities of the methodologies because we would be here for quite some time. But in essence what we are seeking to do is to identify the unmanaged ESG risk that companies have. And the way that is, we first of all identify the exposure that companies have to E, S and G issues, based on the industry they’re in and the country that they’re operating in. Then after that we’re looking to identify and assess the various programmes, the policies, and procedures that these companies have in place to mitigate those ESG risks. So, then the final output that we have is a rating based on our assessment of how well companies are doing in mitigating the ESG risks that they face.
7.08 – Robin Powell | Host: Sustainalytics recently changed its methodology from ESG ratings to ESG risk ratings. What motivated this change and why is the new methodology an improvement?
Eoghan Gill | Sustainalytics: Yes, correct. That was a few years ago when we moved from what we called our ESG ratings to what we now call our ESG risk ratings. I think the first and most obvious change is the change in the name. We’ve now moved to a more risk-based metric, and as we know, investment management is all about risk management on a daily basis. So, what we were seeking to do with this change is to give investors a risk-based metric that they can integrate along with the rest of their risk management, in order to better inform their investment making decisions.
The other thing that changed within the rating itself was that previously we were just looking at ESG performance. But now we’ve added that two-dimensional approach which I just mentioned. We have now added exposure to that, as well as the management, so we’re getting more granular in terms of the ESG risk the companies face.
The third change, and I think this is the most important, is that with the previous rating we only looked at performance relative to other companies within the same sector. The score only showed how well you performed against other oil and gas stocks or other publishing stocks. But our new ESG risk rating allows you to compare the performance of these companies across different sectors. What that means then is whenever you have a multi-sector portfolio, you’re now able to compare companies across sectors. So, it’s apples-versus-apples rather than the apples-versus-oranges approach.
9.16 – Robin Powell | Host: Could you explain what “Product Involvement” means?
Eoghan Gill | Sustainalytics: Product Involvement for us at Sustainalytics is revenue that’s derived from product areas that would be seen as non-ethical or against people’s values. So very obvious examples of that would be revenue derived from alcohol, revenue derived from tobacco, revenue derived from weapons, revenue derived from oil production.
So, it’s about trying to identify those areas. It’s not up to us at Sustainalytics to say whether involvement in those things is good or bad. It’s simply our job to identify those and then pass it on to the investor. And then, based on their mandate or their clients’ requests, they can then use that to better inform their investment decision-making.
10.27 – Robin Powell | Host: What does the “Controversy” level mean?
Eoghan Gill | Sustainalytics: Yes, so Controversy one [not sure what “one” means …maybe insert “level” instead] is where we start to bring together the range of technologies that we have along with the analysts that work within Sustainalytics. Essentially what we’re doing here is identifying any controversies or events that have taken place, for those companies that we have research on. If there is a controversy that takes place we have artificial intelligence scanning around 700,000 different news sources every day, 24/7, 365 days a year. That will flag that the controversy is taking place. That then is passed through to our team of analysts, and our analysts then assess the controversy, the event, and then provide a rating It might be a level one, which is the lowest severity, or you go right up to a level five, which would be something like the Vale dam collapse which happened a few years ago. So that’s what we’re seeking to find, and then have that reflected in the risk ratings of the companies on an ongoing basis.
12.18 – Robin Powell | Host: Typically, how regularly is a company reviewed and assigned its ESG risk scores? Are there circumstances when this is done more frequently?
Eoghan Gill | Sustainalytics: That’s a good question and one that is frequently brought up by investors. We’re so used to things changing second by second, minute by minute, but with ESG it’s a slight bit slower. So typically, we would do a food company review once a year and that will always be after the full year financial reports, and that allows us then to go through and identify the different policies or programmes that they may have implemented throughout that year. But if there has been a controversy or an event that takes place, like I just talked about, that will be assessed and integrated into the score as and when those happen. The main review will be once a year. However, if there are controversies, they will be reflected as and when they happen throughout the year.
14.00 – Robin Powell | Host: Why do the data providers come up with such widely differing views over the same company?
Eoghan Gill | Sustainalytics: So, it is again something that we discuss frequently with investors as they are looking at these ratings and our assessments. For me anyway, ESG, or responsible investing, is such an emotive topic. What is ESG to you, Robin, might be slightly different to what is ESG to me. The fact that there are slight differences in how companies like ourselves assess these ESG performances is, in its way, a good thing, right? Because it allows you then to say, “Well, this is what I expect from an ESG policy, and this is what my investors expect, therefore I can align that expectation with Sustainalytics ratings.”
Then if someone else has a different opinion, that allows them to align with the research or the data that they’re getting with another investor. The key to then going beyond that and understanding what the ratings are is the transparency that’s provided by the rating agencies themselves. The investors know what they’re looking at, they know what they’re assessing, and then they’re able to pass on to their clients what their ratings mean, what the data means and how that impacts their investments.
16.23 – Robin Powell | Host: Is there more consistency across providers within any of the pillars / risks (i.e., E, S, or G)? For example, will most (or all) providers agree on the worst environmental polluters but perhaps not on the worst for social issues?
Eoghan Gill | Sustainalytics: I’m not so sure about consistency per se, but I think you’ve touched on an important point there about the social or the values alignment to how we do our assessment. Like I said earlier on: whenever it does come to things like product involvement, it’s not our judgment – nor do we provide a judgment – on whether involvement in these certain areas is good or bad. What we do is we produce the data and the research and then we look at what risk the company faces because of the involvement within those certain areas. And if you are, say, a car company that isn’t changing its fleet towards an electric vehicle fleet, but you operate in a region where the expectation is that the market will move towards electric vehicles, then we’ll highlight that as a risk. We are still not going to say if it’s good or bad, we’re just saying that that’s a risk that you, as an investor, has to deal with. That’s sometimes then when the discrepancies come between the rating agencies: because how they view risk might differ between different houses. In the same way, you could go to one active manager who looks at a particular stock, looks at the fundamentals, and identifies a risk that an active manager in another investment house might look at and think that it’s not a risk. So, there are discrepancies between fund managers on what’s a good valuation; this also trickles across into the ESG world as well.
19.23 – Robin Powell | Host: Perceptions of what constitutes an ESG stock change over time, and sometimes quite quickly. For example, the Ukraine crisis has changed the way some people think about the weapons sector.
Eoghan Gill | Sustainalytics: I think you bring up a very good point, and unfortunately it is quite timely. What we do in that field is, again, we identify what would be classed as controversial weapons and normal weapons, i.e., those that wouldn’t be banned by international norms and conventions. Again, all we do is we just outline the facts about these companies that are producing non-controversial weapons and these companies that are producing controversial weapons. We give that to the investors and it’s their choice what they do with that information. We are just passing on that data or that research that they may not previously have had. We’re not trying to sway anyone’s opinion on what they should or shouldn’t do. It’s their fiduciary duty how they invest their money. All we do is highlight the facts, and hope they do something positive with it.
20.55 – Robin Powell | Host: Does the fact that ESG ratings often diverge across ratings providers undermine their usefulness to investors?
Eoghan Gill | Sustainalytics: No, I think if the investor knows what they’re looking at in terms of what sits behind the rating – the methodology, the data that goes into it – and they understand and they can interpret that, and that aligns with their ESG policy, then I think that’s the most important thing here. Because we’re then passing on the information that is most useful to them, and to their policy – therefore their clients and their fiduciary duty. We’re also seeing a lot of asset managers who are bringing in multiple ESG rating provider sources, and they’re able to then compare and contrast across Sustainalytics, across MSCI, across ISS, and make sure they’re getting a holistic picture. Because then, if we are all bringing different parts of the information to the table, at least then we’re presenting that to the investor and that makes them even more informed as a result.
22.52 – Robin Powell | Host: To what extent are we seeing the opinions of different ratings agencies being aggregated?
Eoghan Gill | Sustainalytics: We have had that, to a certain extent, and that’s through various regulators bringing in policies or standardisation – so the most obvious example recently is the EU Action Plan that has brought in a taxonomy on how companies are to be assessed, and how investment managers who want to class their portfolios as being green should report on those. What you’re seeing is, at a high-level, convergence where standardisation of reporting is available. All that really does is cover the high-level, but what investors are still looking to know is more than that. So Sustainalytics can provide further research and data than just the data points required to fulfil your EU regulatory requirements – so there’s still a need then for us to be able to provide that to them, for them to have deeper insights to then provide to their clients. A unique aspect to ESG that you wouldn’t get if everyone just follows the same standardised reporting, which people will still do, but it just still allows the uniqueness and the USPs to be developed.
22.44 – Robin Powell | Host: How does Sustainalytics deal with vastly differing ESG regulatory reporting requirement imposed on companies – esp. developed markets vs emerging markets (but even within developed markets)?
Eoghan Gill | Sustainalytics: One of the key issues that ESG ratings agencies always arrive at is the amount of disclosure from companies and, as you go further down the market cap spec, that can be a contributor to that – or if you go towards emerging markets – the amount of data, because of the disclosure levels, becomes quite limiting One thing that we do, so as not to punish the emerging market companies because they don’t have the large teams to produce these glossy brochures and the nice websites with all their policies and procedures, is: we look at them with a slightly different framework. A framework where we don’t expect them to have the same level of disclosure as the larger developed market companies but that still allows us to be able to perform an assessment that gives us a result in line with those developed companies. Over time, whenever we see regulation like the EU Action Plan increase, we do expect then that disclosure will also increase for these companies, which then gives more data into the market. So, it will come, and it will change – it’s just going to take a slight bit more time.
26.34 – Robin Powell | Host: Would you expect ratings to converge across providers in the future as ESG disclosure requirement increases and standards evolve?
Eoghan Gill | Sustainalytics: Even since I’ve joined Sustainalytics, the amount of coverage that we have for companies has probably increased by about thirty or forty per cent – and that’s only over the space of two-and-a-half or three years. So, at that rate, you’d expect that – especially given now that these companies are for investors that have to report for regulatory purposes – they will start to apply pressure onto these companies that are further down the market cap spec, or are in emerging markets, to start disclosing this information – or they won’t be able to invest in them. So, I think that change is definitely happening. I think over the next five years you’ll see a dramatic increase in the disclosure of companies, but it is going to take a bit of work from investors to create that pressure, over those years.
28.11 – Robin Powell | Host: What impact, if any, does an ESG data provider have in changing corporate behaviour?
Eoghan Gill | Sustainalytics: I wouldn’t so much say that we, as a rating agency, have a direct impact. We certainly have a role to play but we don’t have a direct impact. What I mean by that is – as I said quite a few times here – it’s our role to collect the information and pass it on to investors.
It’s really then up to the investors what they decide to do with that information. Now, we hope that they use it in a positive way – both in terms of how they integrate it into their investment decision-making process, but also then how they use the information to engage with the underlying companies that they are invested in, or they seek to invest in. And I think it’s of no surprise that, since ESG became quite in vogue a couple of years ago in terms of investors, we now can’t turn on the radio, or go on to the internet, or listen to the TV without all these companies talking about what they’re doing to change the planet, in their view. So, there’s definitely been a positive outcome of the past couple of years, and the key now is to make sure that that trend continues, and that the pressure applied from investors is a positive one within the market, and we continue to see a positive impact then on the investment attitude across all investor types.
30.23 – Robin Powell | Host: How do you know that the answers a company gives you are true? Are they not just telling you what you want to hear?
Eoghan Gill | Sustainalytics: Again, that’s another very good point and it’s something that differentiates us from a few of the other rating agency providers, in that we do not send questionnaires to these companies. We do not seek their input into these reports. All that we do is look for the programmes, the policies, and procedures that we expect them to have in place to mitigate these ESG risks, but they’re properly disclosed publicly. So, once we go on to, say, the CSR part of a company’s website, we will then see where the range of policies and procedures are in place. We will read them, we will assess them – if it’s been in a financial report, you know it’s been audited – and then we will take our assessment from that. We do however allow companies to send us information, or programmes or policies, but we don’t do it on a questionnaire-based system simply because we don’t want to be sweet-talked, if you will, by the answers they provide so that’s our way of keeping it as at arm’s length as possible to stop that kind of behaviour.
32.45 – Robin Powell | Host: Is there any evidence to link ESG investing with long-term out-performance or even under-performance?
Eoghan Gill | Sustainalytics: From someone who’s been working in this space for quite a while, I’ve seen both sides of the coin. I’ve seen people who, like you say, argue underperformance and people who argue over-performance, and then those who say, “Well, it’s just circumstantial that there’s been over or underperformance, and you can’t necessarily attribute that to ESG as a result.” I think for myself anyway, I would sit with you in the middle. It can be seen that there is maybe not huge over-performance, but there’s definitely performance in line with the market, if not slightly better. But then I’ll always go back to one of my original comments today, which was: we are a values and a mission-driven business, and that is something that I believe in – the fact that we are trying to improve the allocation of capital. So, a more sustainable world and a more just society is a price to pay, if you do have people here arguing against the performance aspects of ESG.
35.07 Robin Powell | Host: Eoghan Gill, it has been a pleasure to talk you, Thank you very much indeed.
Eoghan Gill | Sustainalytics: Thank you very much Robin.
You’ve been listening to the GSI podcast from Global Systematic Investors.
I’m Robin Powell, and you heard me interviewing Eoghan Gill from Sustainalytics. GSI prides itself on designing, building and delivering portfolios that have better risk and return provides than tradition al market weighted indices. If you like to find out more just visit the website –
Thank you to Eoghan and thanks to you for listening. If you’ve enjoyed this episode, please do review it. We’d love to hear your views. And of course, remember to subscribe to it, so you don’t miss the next one. Until then, goodbye.
PLEASE NOTE: The original interview has been slightly edited for brevity and clarity
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