Quarterly Outlook
Equity outlook: The high cost of global fragmentation for US portfolios
Charu Chanana
Chief Investment Strategist
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How sustainable is your portfolio?
ESG
Find out with ESG Risk Ratings
As the world faces pressing climate, societal and governance challenges, more and more investors are showing an interest in sustainability. Therefore, to make it easier for our clients to identify sustainable companies and help them make investment decisions that are aligned with their values, we have added ESG ratings on Saxo’s platforms.
What are ESG Risk Ratings and how to use them
ESG ratings are measures of how well a company manages material environmental, social and governance risks it is exposed to. Environmental risks (E) are associated with greenhouse gas emissions, waste management and pollution. Social risks (S) involve employees’ safety and wellbeing, as well as diversity, equity and inclusion. Governance risks (G) cover transparency, anti-corruption, business practices and the board of directors’ composition and independence.
Sustainalytics, Saxo's choice of ESG rating provider
The ESG risk ratings shown on Saxo’s platforms are provided by Sustainalytics, a Morningstar company. The rating is based on two dimensions: (i) exposure to material E, S or G risks specific to the company and its sub-industry and (ii) how well the company manages those risks. Companies are assigned both an ESG Risk Score and an ESG Risk Category.- The ESG Risk Score ranges from 0 to 100. The lower the score, the better: (0) is equivalent to no risk and (100) corresponds to the most severe risk.
- There are 5 ESG Risk Categories:
2. Low
3. Medium
4. High
5. Severe
Negligible and low categories are assigned to companies that manage their ESG risks well, whereas high and severe categories are assigned to companies that manage their ESG risks poorly. A medium rating means that some risks are managed well, while other risks are managed poorly.
ESG Risk categories are absolute, which means that a bank can be directly compared with an oil company, or any other type of company.
Filtering for sustainable stocks on Saxo’s platforms
In addition to reviewing a company’s ESG risk rating, it is possible to screen for stocks using a specific ESG risk category. The screener will then only return the list of stocks that meet the specified criteria.
Ratings challenges
Ratings are typically based on historical data, thus they are backward-looking and shouldn’t be used to forecast return potential.
Also, as there are no standards for assessing a company’s ESG practices, providers use different methodologies, which are at times subjective and can result in major differences. Ratings correlations between the major providers are as low as 0.45 (Source Brandon, R. G., P. Krueger, and P. S. Schmidt. 2021. “ESG Rating Disagreement and Stock Returns.” Financial Analysts Journal 77), which is substantial. In comparison, the correlation between credit agencies' ratings is above 0.9 and perfect correlation is 1. This divergence makes comparison difficult, but it can also serve to highlight problem areas that should be further researched by investors.
Conclusion
ESG ratings are valuable in evaluating how a company manages its material ESG risk. They should be viewed as additional due diligence and used in conjunction with traditional financial analysis to make long-term informed investment decisions. The ratings, however, do not tell the full story. They are backward-looking and shouldn’t be used to forecast the future. Lastly, investors are advised to check ESG ratings from time to time to ensure they are still in line with their values.Latest Market Insights
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