There are many challenges in delivering ESG-related advice about mutual funds and ETFs (Exchange-Traded Funds) while considering a client’s overall portfolio and ESG (Environmental, Social, and Governance) preferences. These challenges include the following:
Every client has his/her own values and preferences with respect to environmental, social, and governance issues. One client might prioritize pollution prevention, another addressing climate change, while another may want to focus on diversity and workplace rights. Integrating a client’s values with their investing goals must be considered within the overall context of risk, expected return, sector allocations, and other priorities.
While many funds and ETFs have an ESG or sustainability focus, each one takes a unique approach to ESG investing based on its own criteria. Without assessing a fund’s individual holdings, it is impossible to evaluate the fund’s actual ESG profile.
“Greenwashing,” as noted in the article by Judd Legum, is a serious concern as funds can claim to engage in ESG-focused investing without providing evidence that they actually do so. In fact, the SEC is cracking down on funds marketed as “ESG” or “Sustainable” that are ESG in name only.
To ascertain true ESG fund and ETF alignment, The Prosperity People uses an ESG screening company that employs consensus scores to address the challenges mentioned above. The firm uses a “wisdom of the crowd” approach that takes into consideration multiple ESG reviews from the world’s leading ESG data and research firms. The reason we do this is because, on average, the correlation between any two vendors’ ESG ratings on the same security is less than 50%. The reason for this variability is because each ratings firm has their own methodology, data, and metrics to determine a company’s ESG profile. As a result, there is extreme inconsistency across ratings firms and by relying on any single provider’s ratings, end-users are choosing one firm’s opinion from among many — hence, the focus on finding a “consensus” score.
Our research provider reviews each ESG analytical organization to determine which metrics it has determined to be most relevant for its ESG ratings within each industry. Metrics that are considered material to an industry by more ESG analytical organizations receive a greater emphasis in determining the consensus scores. Scores are defined by four pillars: Earth (“Environmental”), Employer & Citizenship (two distinct aspects of “Social”), and Governance. Each pillar has its own score and all four are combined to create a company’s overall ESG consensus score.
These four pillars are constructed from hundreds of metrics related to ESG behaviors and financial performance that are summarized into 12 KPIs (four pillars with three KPIs per pillar). Each pillar has its own score, and all four are combined to create a company’s overall ESG consensus score.
Earth — Pollution Prevention, Environmental Transparency, Resource Efficiency
Employer — Compensation & Satisfaction, Diversity & Rights, Education & Work Conditions
Citizenship — Community & Charity, Human Rights, Sustainability Integration
Governance — Board Effectiveness, Management Ethics, Disclosure & Accountability
Per our ESG research provider, over 18,000 companies are regularly reviewed to see where they score on the ESG consensus matrix. The vast majority of mutual funds and ETFs that are available to the public are then reviewed to understand the composition of each and an aggregate ESG consensus score is created for each mutual fund and ETF, which provides more clarity on the degree to which it is practicing socially responsible investing.
In summary, our ESG research provider’s unique consensus score integrates insights across a wide group of diverse sources, providing a thoroughly researched framework for identifying mutual fund and EFT adherence to ESG-based standards.