Responsible Investors Should Focus on ESG “Offenders”
Investing in companies that have favorable ratings on environmental, social and governance (ESG) issues has become increasingly popular. But investors might do better targeting companies with poor ESG ratings and a clear commitment to mend their ways.
Searching for companies with weak ESG records might sound counterintuitive. But in fact, identifying companies that are on track to materially improve their ESG performance can yield positive outcomes for both investors and society.
Investors play an important role in motivating these companies to change, through active engagement, proxy voting and other tools available to active managers. Companies that successfully change their ESG practices—what we call “ESG Improvers”—are often on a path to improving their financial and operational performance, which drives better returns.
What’s Wrong with ESG Ratings?
ESG ratings are the backbone of responsible investing. They provide a snapshot of a company’s performance on a range of issues, from protecting the environment to gender equality. But they can be misleading. They don’t really help investors identify companies that are ready to change. And our research has shown very little correlation between ESG ratings and excess returns.
MSCI, a leading ESG ratings provider, has demonstrated a correlation between improving ESG ratings and investment returns. Our research confirms this correlation and shows that companies with the lowest ESG ratings—or no ratings at all—deserve special attention.