Sustainable Investing & MSCI ESG Ratings

 

Sustainable Investing

Sustainable investing is used as an umbrella term to describe investment strategies that combine traditional security analysis with environmental, social, and governance insights.

ESG describes the Environmental (E), Social (S), and Governance (G) metrics that are evaluated to inform security selection.

ESG analysis evaluates risks and opportunities beyond the scope of traditional financial analysis.

Overview of MSCI ESG Ratings

 MSCI rates companies according to their exposure to industry specific ESG risks and opportunities and their ability to manage those risks and opportunities relative to peers.

The company level ratings are aggregated to the fund level, which are further aggregated to the portfolio level to provide the ESG rating available on the Sustainability tab of the 360 Evaluator.

The MSCI ESG Ratings model seeks to answer four key questions about companies1:

  1. What are the most significant ESG risks and opportunities facing a company and its industry?
  2. How exposed is the company to those key risks and/or opportunities?
  3. How well is the company managing key risks and opportunities?
  4. What is the overall assessment of how the company is managing ESG risks and opportunities and how does it compare to its global industry peers?

The key issue scores and weights are combined and normalized per industry to offer an overall ESG score (0-10) and rating (AAA-CCC) for each issuer.

 

MSCI ESG Fund Ratings and ESG Quality Scores

The overall MSCI ESG Fund Rating and MSCI ESG Quality Score measure the ability of a fund’s underlying holdings to manage key medium- to long-term risks and opportunities arising from environmental, social and governance issues. The MSCI ESG Quality Score is provided on a 0-10 scale, with 0 and 10 being the respective lowest and highest possible fund scores. The MSCI ESG Fund Rating is provided on a AAA-CCC scale, with AAA and CCC being the respective highest and lowest possible fund ratings.

Derivation of MSCI ESG Fund Rating from underlying company scores

The MSCI ESG Fund Rating is calculated using an enhanced holdings-based methodology that incorporates the following:

  • the underlying holdings’ Weighted Average ESG Score.
  • the fund’s ESG Momentum, including the fund’s exposure to holdings with an improving ESG rating trend (positive) and the fund’s exposure to holdings with a worsening ESG rating trend (negative).
  • the fund’s exposure to ESG Tail Risk, specifically holdings with CCC and B ESG Ratings.

The net exposure of positive trend, negative trend and tail risk are applied as a multiplier to the weighted average score to calculate the MSCI ESG Quality Score. The MSCI ESG Quality Score is then converted to a letter rating that ranges from AAA-CCC.

Each fund has a coverage %, which represents the percent by weight of a fund’s holdings (excluding cash positions and other asset types deemed not relevant for ESG analysis by MSCI) that have ESG data. Holdings that do not have a rating are excluded from the calculation.

Funds included in MSCI ESG Fund Ratings

To be included in MSCI ESG Fund Ratings, a fund must pass the following three criteria:

  • To be included in MSCI ESG Fund Ratings, 65% of the fund’s gross weight must come from securities with ESG coverage by MSCI ESG Research (certain cash positions and other asset types like securitized products, commodities, currency, and others are not currently covered by ESG analysis by MSCI are removed prior to calculating a fund’s gross weight; the absolute values of short positions are included but treated as uncovered)
  • Updated Holdings Data: Fund holdings date must be less than one year old.
  • Portfolio Holdings Minimum: Fund must have at least ten securities.

Calculation of portfolio level ESG metrics

The portfolio MSCI ESG Quality Score is based on the weighted average ESG Scores of the underlying funds & stocks within the portfolio. Security weights are adjusted for ESG coverage and normalized to 100%. The resulting weighted average ESG score is then adjusted based on portfolio exposure to issuers with positive trending ESG scores, issuers with negative trending ESG scores, and ESG Laggards (B and CCC rated issuers). The result is the ESG Quality Score, which can be mapped directly to the letter ESG Rating.

 

1 MSCI ESG Ratings Methodology, December 2020 - https://www.msci.com/our-solutions/esg-investing/esg-ratings 2 Source: MSCI ESG Research. Data sources: 1000+ data points on ESG policies, programs and performance, Data on 65,000 individual directors, 13 years of shareholder meeting results, 1600+ social media sources monitored daily. MSCI issues scores and weights to combine overall ESG rating relative to industry peers