Differences between ESG scores among data vendors

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Emma Cross
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1 ESG Ratings Differences between ESG scores among data vendors Duane R. Roberts, CFA Director of Equities Photo by JLKG 6/2018 Rocky Mountain National Park Since the wave of new ESG specific and larger well-known data vendors rolled onto the ESG data scene, engulfing other providers along the way and since, it has become more difficult for investors and managers to find any high-level of correlation between the vendor ESG scores. The following discusses some of the possible reasons for the differences in scores across companies and how investors and managers might navigate these challenges to drive mission alignment, risk mitigation and alpha generation.

2 ESG Ratings As interest in social or responsible investing has rapidly expanded, an ecosystem for relevant data has evolved. Data covering environmental, social and governance (ESG) factors have become important not only to investors seeking a responsible investment approach, but also to a much broader investment audience. This wider audience sees the opportunity for ESG data to enhance security selection as ESG data show potential for both risk reduction and alpha generation. Specialist ESG data firms have been joined by major financial data vendors. Many investors look to these vendors for a single source of ESG data, and ideally for a single summary measure of ESG performance. Several data vendors provide an overall composite ESG score, in addition to sub-scores and in some cases hundreds of atomic ESG data items per company. Dana Investment Advisors (Dana) also produces a composite ESG score as well as a variety of components to assist in our efforts to integrate ESG factors into our stock selection decisions. With high-level ESG ratings now being provided commercially by multiple vendors, investors are asking how these ratings compare. This note makes a brief comparison through a correlation analysis of several ESG ratings covering U.S. stocks. Suppliers of ESG Ratings Dana has participated in the evolution of ESG data since 2000, when we began managing our first socially responsible equity portfolio. As our efforts, experience, and assets under management in this area grew, we continually monitored the ESG data landscape, looking for improved sources of information to assist in our management decisions. Dana witnessed the evolution from a handful of small specialized data providers with limited coverage of stocks and ESG factors, to an ecosystem where the major financial data vendors now supply ESG data and dedicate substantial resources to this effort. Other data vendors produce ESG/SRI/CSR ratings or scores, so this document is far from exhaustive in its coverage. Institutional Shareholder Services (ISS), which was spun out of MSCI following MSCI s acquisition of RiskMetrics and has since acquired Ethix, IW Financial and South Pole Group, does not (yet) provide an ESG rating. Dana has used scores from IW Financial for over a decade, but since these scores are based on Dana-defined profiles and would differ for any other user, the scores are not included in the correlation analysis. CSRHub produces scores that Dana also uses but are omitted from this document due to update cycles. Other ratings firms that Dana does not currently use but are worth monitoring include RepRisk, Oekom Research (which merged with ISS in 2018), Vigeo Eiris, and more. A brief description of some of the leading providers of ESG data on U.S. stocks* are included at the end of this document. Defined as stocks of companies whose primary equity listing is on a U.S. exchange, regardless of where the company is domiciled. Correlations Between ESG Ratings With several major data vendors now providing an overall ESG score or ranking of companies, an investor might wonder how much agreement exists between the various ratings. One way to gain insight into this question is to examine the correlations over a universe of companies between any two vendors. Dana has computed the correlations between several vendors over an overlapping universe of U.S. stocks*. For the firms with the broadest U.S. coverage (Sustainalytics and MSCI), the universe is approximately the Russell 3000 Index members. The correlations between pairs of vendors are shown below. In addition to the vendor correlations, we show the number of stocks for which we have ratings from each vendor. The final column, Size Correlation, is the correlation of that vendor s ratings with company size. *Defined as stocks of companies whose primary equity listing is on a U.S. exchange, regardless of where the company is domiciled. ESG Vendor Correlations (data as of 9/30/2018) All Observations (~Russell 3000) # of Size Stocks Correlation (1) MSCI % 31.09% 34.85% 30.82% 54.36% % (2) Sustainalytics % 61.00% 75.04% 47.76% % (3) RobecoSAM % 76.94% 70.56% % (4) Thomson Reuters % 70.56% % (5) Bloomberg % % (6) Dana ESG % Sources: Dana Investment Advisors, MSCI, Sustainalytics, Thomson Reuters, Bloomberg, ISS, FactSet. Size Correlation column measured by logarithm of market capitalization.

3 ESG Vendor Correlations (data as of 9/30/2018) Russell 1000 Constituents # of Size Stocks Correlation (1) MSCI % 34.68% 40.74% 36.47% 58.12% % (2) Sustainalytics % 67.68% 76.66% 59.16% % (3) RobecoSAM % 74.46% 67.71% % (4) Thomson Reuters % 67.71% % (5) Bloomberg % % (6) Dana ESG % Sources: Dana Investment Advisors, MSCI, Sustainalytics, Thomson Reuters, Bloomberg, ISS, FactSet. Size Correlation column measured by logarithm of market capitalization. Correlations Between ESG Ratings (continued) Many people we talk with are surprised that these correlations are not higher. Why is there not more agreement in the results? We suggest three influences that reduce the observed correlations. First, ESG remains inherently subjective. While all vendors are incorporating environmental, social and governance factors in their assessments, the specific data points and relative importance of various data vary from vendor to vendor (individual investors might vary even more). Second, while some ESG information is company-reported and should therefore be consistent from vendor to vendor, other data may result from vendor or third-party research that yields different values even when attempting to measure the same thing. Third, each vendor has developed a unique methodology to produce rankings. All of these approaches have distinctive strengths, but as they often measure contrasting aspects of ESG performance and process data in varying ways, differences in the rankings are inevitable. The vendors with the broadest coverage of U.S. stocks, MSCI and Sustainalytics, have scores with a correlation of 40.3% over the Russell 3000 Index constituents, and slightly higher correlation of 48.6% over the large-cap Russell 1000 Index constituents. MSCI s approach varies the metrics used for different industries, reflecting its views on materiality. While desirable to focus on the most important factors for each industry, this approach introduces additional subjectivity and makes comparisons across industries difficult. Sustainalytics scores are more uniform across industries, and emphasize transparency, policies, and governance structures relating to ESG issues. Reading the methodology documents from both vendors reveals two thoughtful and potent processes, but with disparate approaches that should be expected to lead to different results. Bloomberg does not provide an ESG rating, per se. The Bloomberg score used in this document is an ESG disclosure score. Looking at correlations with this Bloomberg score suggests that Sustainalytics, RobecoSAM and Thomson Reuters all use disclosures as significant inputs to their ESG scores (which Sustainalytics confirms in their documentation). MSCI scores appear to have greater influence from other factors. Dana s composite ESG score incorporates all of the listed data vendors scores at the E, S and G pillar level and data from a host of other financial data providers and other sources (non-profits, NGOs, etc.). Our scores show modest correlation with the other vendors scores. Note that the Dana ESG score has a low correlation with Bloomberg s disclosure score. This is consistent with our desire to emphasize execution metrics (GHG emissions, political spending, diversity metrics, etc.) over policies and disclosures. It appears that RobecoSAM s survey-based approach is fairly consistent with our view of ESG measurement, as Dana s ESG scores are most highly correlated with the RobecoSAM scores, though RobecoSAM has the lowest coverage in terms of number of stocks, which may be introducing other effects into the correlation. As a final note, we computed correlations between the various ESG scores and company size. We use the logarithm of market capitalization as the size metric, to avoid excessive leverage from mega-cap companies in the correlation calculation. It has been our impression over many years that third-party scores tend to favor larger companies and this is confirmed by the size correlations. Part of this may be due to better management of ESG issues by larger companies who have greater resources and perhaps greater reputational risk from a negative ESG event. But we also speculate that some of the bias stems from the existence of more formal policies, structures and disclosures at larger companies, which may be relatively costly for smaller companies to match. While transparency and management of ESG issues are very important, there is an uncertain connection between formal policies and documentation and actual ESG performance.

Sample List of Data Providers of ESG Ratings MSCI An index provider that expanded to other analytical tools for the investment industry, MSCI entered the ESG data field in 2010 by acquiring

4 Sample List of Data Providers of ESG Ratings MSCI An index provider that expanded to other analytical tools for the investment industry, MSCI entered the ESG data field in 2010 by acquiring RiskMetrics Group, which had previously acquired ESG-related firms Institutional Shareholder Services, KLD Research and Innovest. In 2014, MSCI acquired GMI Ratings. By combining and building upon several of the previous foremost purveyors of SRI/ESG data and research, MSCI became a leader in the U.S. market and provides more ESG data points (1,000+) than any other vendor. MSCI provides Intangible Value Assessment (IVA) scores to rate the risks and opportunities faced by companies related to ESG factors. Sustainalytics Sustainalytics was formed in 2009 as the culmination of a decade of partnerships among several European sustainable investment research groups, which combined later that year with Jantzi Research in Canada. Sustainalytics provides qualitative research on companies and sustainability issues. The company developed a quantitative rating covering large cap stocks, and recently expanded coverage with new scoring covering the Russell 3000 Index members. Sustainalytics ratings, combined with Sustainalytics data on controversies, power Morningstar s ratings of the ESG performance of investment funds. Morningstar acquired a 40% stake in Sustainalytics in Thomson Reuters Thomson Reuters became a meaningful ESG data provider when it acquired Swiss firm Asset4 in Building on its existing database of company data and the Asset4 foundation, Thomson Reuters provides its clients with an expanding offering of ESG data and ratings. The current Thomson Reuters ESG score was introduced in late 2017 as a replacement for the legacy Asset4 scores, which will be retired in The score is a weighted combination of 3 environmental, 4 social and 3 governance sub-scores. Thomson Reuters also produces ESG controversies scores. RobecoSAM SAM was founded in Switzerland in 1995 as an asset management company dedicated to sustainable investment themes. The firm was acquired by Robeco in 2006 and renamed RobecoSAM in RobecoSAM performs its Corporate Sustainability Assessment (CSA) based on industry-specific questionnaires it sends to large companies around the world. CSA is used to determine the Dow Jones Sustainability Index family, which provides an incentive for companies to respond to the questionnaires. Being survey-based, CSA results are not as broad in terms of company coverage but are available on over 2,000 companies worldwide. Bloomberg Bloomberg is the leading provider of data to the investment community and has devoted significant resources to expanding its ESG data and tools in recent years. Bloomberg bought New Energy Finance during the wave of ESG data mergers that took place in 2009, but much of its ESG data has been organically grown. Bloomberg also provides third-party ratings and data from firms including Sustainalytics, RobecoSAM, and CDP. Bloomberg trails MSCI in terms of the number of data items but covers more companies worldwide than any of the other vendors. Unlike the other providers listed above, Bloomberg does not generate an ESG performance score or rating but does produce an ESG disclosure score and sub-components.

DANA Investment Advisors Physical Address: 20700 Swenson Drive Suite 400 Waukesha, Wisconsin 53186 Mailing

5 DANA Investment Advisors Physical Address: Swenson Drive Suite 400 Waukesha, Wisconsin Mailing Address: P.O. Box 1067 Brookfield, Wisconsin (262) (800) Photo by JLKG 8/2017 Eclipse Week

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