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Do ESG ratings go far enough?

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While benchmarks for sustainable investing are helpful, they may be “insufficient” in identifying the specific impacts of environmental regulations, an asset management firm has said.

According to Lazard Asset Management co-CEO Jeremy Taylor, active managers may be better equipped to analyse the flow-on effects of environmental regulations on companies and sectors and as such could offer environmental, social and governance-aligned investors an advantage.

“Active, bottom-up fundamental managers are better able to anticipate the risks and opportunities created by structural shifts compared to other approaches that rely on static assessments, owing to a thorough appraisal of financial statements and regular engagement with company management to generate unique insights into how different businesses are developing,” Mr Taylor said.

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In a recent research paper, Mr Taylor, together with Nathan Cockrell, Alistair Godrich and Neil Millar, noted that investors are increasingly relying on environmental, social and governance (ESG) ratings to provide insights and guide decisions.

“While ESG ratings offer valuable inputs, we believe that in isolation they are insufficient to accomplish our objectives as they have some shortcomings that we believe can only be resolved through rigorous bottom-up fundamental analysis,” the researchers said.

“Frequent and thorough company engagement and the integration of meticulous ESG analysis into investment processes could potentially help investors sidestep the significant losses that tend to accompany ESG failings.”

The researchers put this down to the differing impact of ESG factors on companies, sectors, regions and time frames.

“While there is a growing acceptance that a company’s ESG practices can affect its valuation and financial performance, tying the underlying factors together is rarely a straightforward process, as many factors relating to ESG are often subjective, and difficult to track and quantify,” the researchers said.

The difficulty in anticipating and understanding the impact of environmental considerations on the automotive, shipping and oil refining sectors in particular is an example, the researchers said.

“These three sectors serve to illustrate the structural shifts and second-order effects that are being created by vast swathes of environmental regulation. Understanding the impact of these factors on a company’s outlook and being able to anticipate them can be a challenge, even for well-informed investors,” the researchers said.

Do ESG ratings go far enough?
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