ESG scores could be the credit ratings for stocks

ESG scores could be the credit ratings for stocks

ESG scores could be the credit ratings for stocks

According to a growing body of research, ESG ratings can give investors an idea of reputational and regulatory risks that a company faces. Because of that, strong ESG ratings can add to a company’s share value.

But it’s not just the current ESG scores that investors ought to pay attention to. According to a recent study by MSCI titled How Markets Price ESG, changes in the scores also have a direct “causal” impact on a company’s stock price.

The study builds on previous research from 2017, which found that ESG ratings were a descriptor of risk. The implication, which the author of the new study sought to confirm, is that a change in the rating would have a corresponding effect on the price of a stock.

“The economic logic was there but what was surprising was how it worked out,” Guido Giese, MSCI director of Applied Equity Research, told ThinkAdvisor.

Among the most significant findings was that changes in ESG characteristics resulted in stronger equity-price movements over a one-year time horizon compared to both shorter and longer timeframes. The reactions to ESG information were strongest for companies whose scores were neither very low nor very high. In addition, equity markets showed a stronger reaction to improved ESG characteristics than to deteriorating scores.

Giese said that other factors were also modeled and studied to determine if they had any material contribution to changes in stock price; in the end, they found no other variables that could explain why companies that received ESG rating upgrades have outperformed ESG downgrades.

“Investors look at credit ratings [to give] them an idea of how safe the stock is, but also [they watch] upgrades and downgrades,” he said. “ESG rating is a measure for risk profile, [that is] on how well the company is managed.”

He concluded that investors should consider using ESG scores and changes in the investment process. The idea of using ESG momentum as the basis for an investable benchmark, he added, is something that index engineers at MSCI are currently working on.

While the practice makes sense on paper, it may not be so easy to practice at the moment. One major hurdle for ESG adoption has been the lack of consistency in the assignment of ESG scores, which is partly due to different methods of data collection and analysis employed by ratings providers.

 

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