Inadequate third party ESG scoring systems used by some fund managers could be excluding some of the best small and mid-cap investment opportunities from portfolios.
The warning, from Hermes Investment Management, came on Tuesday (16 July) after the fund group voiced concerns over the prevalence of industry ESG scoring models which have become common across the fund management industry.
The company warned that there is a “scarcity of clear disclosures from small and mid-cap companies” compared to their larger cousins, and this may lead some fund groups to rely on “simple answers” from scoring models and third party data.
“The disparity between larger and smaller companies’ disclosure of basic ESG metrics is striking and even in developed markets, ESG disclosure levels can be very patchy,” explained Hamish Galpin, lead manager of the Hermes SDG Engagement Equity Fund.
“The lack of readily available ESG information in the small and mid-cap segment means that proactive engagement with company boards is required. Investors are unlikely to find such information from off the shelf tools, i.e. published databases, given the lack of disclosure.”
Galpin’s warning comes as the availability of ratings systems, data sets and scoring models for ESG analysis has exploded in the past year. Many of these, however, have been focussed on large cap equity issuers and give scant details of how their methodologies apply to companies in the small or mid-cap universe.
“The information found on databases is by definition, historic, which compromises ratings derived from that data,” Galpin added.
“ESG ratings can certainly raise red flags about major issues within companies, but in aggregate, the scores have some clear shortcomings.”