ESG Rating Divergence: Beauty Is in the Eye of the Beholder

Abstract

Investments aligned with environmental, social, and governance (ESG) principles are rapidly growing globally. In the exchange traded fund (ETF) industry, this gives rise to the power of ESG rating firms that have the influence to direct capital flows into ETFs tracking the indexes. This article examines the issues of substantial ESG rating divergence across rating firms, the impact on investors’ choices, and the influence on the ETF industry. The divergence appears to be the greatest in social and governance components, and is often qualitative in nature. The author found that certain economic sectors are more prone to ESG rating divergence than others. She presents a case study about two ESG ETFs that are viewed quite differently under various rating lenses, and offers suggestions to investors, advisors, and analysts on how to research ESG ETFs, given the major rating divergence. The article concludes with ways the ETF industry could improve its practices collectively to better serve investors with clarity and to sustain the growth of ESG impact investments.