Investing

What is ethical investing and how is it measured?

17 September 2020 | Posted by Anna Panayi
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The world of ethical investing is murky, so let’s bring some clarity to it.

Here at Claro, we aim to declutter the world of finance and help our community make more informed choices with their money. In this article, we’ll be giving an under the hood look at the following items:

Why ethical investing is important for us
What ESG, one of the most commonly used terms in ethical investing mean and how to interpret it
Overview of some of the frameworks used to measure how ethical investments are calculated
How we capture our ESG data and the framework we use

So let’s dig in.

What is ethical investing?

Ethical investing is often also referred to as environmental, social and governance practices (ESG), socially responsible investing (SRI), and impact investing. It means making investment decisions based on your ethical principles and core values. Example focus areas include sustainability, social change, or how a company or country conducts itself.

Investors can find the terms confusing as they are often used interchangeably to cover a broad spectrum of goals and strategies, and the line between them is blurred.

What is an ESG score?

ESG stands for Environmental, Social and Governance. It is a set of standards that measures how well a company performs against them. Along with traditional analysis, it can be used to check investments for those who are conscious where their money is going. There are many agencies that provide ESG ratings, and boards that provide frameworks for these agencies to use. ESG has its own challenges, and this is something we aim to address at Claro, to make it easier for you. Let’s take a further look.

Why is ESG misleading?

ESG can be misleading as the ratings are dependent on information that companies disclose. This data tends to be historic which means that ratings can be outdated. Some information isn’t openly available on published databases therefore it’s hard to know where to look. This means there is little awareness and knowledge for everyday savers and investors.

On top of this, ESG ratings can differ between rating agencies, and there is low correlation according to Bloomberg and MSCI. So with a lack of transparency and inconsistency in data where can you turn to?

We conducted a survey with 1500 members of the public which highlighted that 59% of participants were unaware of what ESG even was.

Different rating agencies and frameworks

There is a lot of information that needs collecting to calculate an ESG rating. Disclosed information from companies is not enough to create an unbiased rating and so there are other factors to consider:

Public information
Media news
Government and NGO (Non-Government Organisations) data sets

This has its challenges, as it means processing a lot of different information, which is not always in a data format. And so technology is required to interpret the results. As each rating agency interprets this data in their own way, this causes differences in results.

Let’s take a look at MSCI as an example

This is one of the most mainstream and widely used rating agencies, published by Morgan Stanley. It categorises 8,500 companies and 680,000 securities across the world according to 37 key issues across ESG. Issues include climate change, human capital and corporate behaviour.

These companies and securities are ranked against industry peers and given a rating between AAA to CCC.

CCC is the lowest rating and relates to companies or securities that have higher risks to ESG. E.g a technology firm who has no diversity, a high turnover rate or poor training for staff would have a lower rating
AAA are leaders in their industry and manage ESG risks and opportunities well. E.g a company with a strong culture, employee satisfaction and focus on diversity & inclusion would have a higher rating.

For more information on the MSCI rating calculations click here.

Each rating agency has a different set of metrics it uses to calculate its scores. This is why frameworks are important to help with this lack of standardisation. Let’s take a look at one that is growing its influence and popularity.

The SASB framework

The Sustainability Accounting Standards Board is a framework that looks at the financial or operational conditions of a company affected by ESG. This framework is unique compared to others, as it looks at these conditions on an industry level. It has developed a set of 26 business-related issues across 5 key dimensions:

Leadership & Governance
Environment
Business Model & Innovation
Social Capital
Human Capital

These areas are then ranked across 77 industries. There are many categories that can affect an industry, and you can see this on the SASB Materiality Map here.

If we take the Consumer Goods sector as an example, within this umbrella is E-Commerce. Now if we use ASOS, there are many categories within the 5 dimensions that can have an impact on the company.

Environment dimension – Energy management
Social Capital dimension – Customer privacy and data security
Human capital dimension – Employee engagement, Diversity & inclusion

Why have we chosen the SASB framework?

At Claro, we want to ensure that we are as transparent as possible, by using data sources that provide high-quality and in-depth analysis. The SASB framework makes this possible. Different from other frameworks, it focuses on the financial impact of ESG on a company.

We have partnered with TruValue Labs who apply their own metrics to the SASB framework. This allows us to get more valuable insights into data that matters. Moreover what makes this data even more powerful is that the insights are available across short, medium and long term investments. This gives a better view of what is performing well or not. Unlike other rating agencies such as MSCI, TruValue Labs looks at how the world is impacting a company’s financials.

An example of this in action is TruValue Labs Coronavirus ESG Monitor. This gives almost real-time data of what is happening across markets as a result of COVID. It is free for the public to use. These types of tools are powerful indicators as they provide meaningful insights that matter now. Look out for future articles where we will discuss TruValue Labs in more depth.

Key takeaways

Ethical investing has many names but all refer to investing in according to your core values
ESG can be misleading due to the vast amount of data and how it is interpreted. It is not easily available for everyday investors
Out of the multiple frameworks, Claro uses SASB in partnership with TruValue Labs as it provides clear and high-quality insights on ESG data

When investing, your capital is at risk.


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