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MSCI under fire for ESG ratings ‘biases’ that could cost investors

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In a previous blog post in November, Klement had noted that companies with better share price performance were more likely to receive a strong ESG rating under MSCI than competitor Refinitiv.
In a previous blog post in November, Klement had noted that companies with better share price performance were more likely to receive a strong ESG rating under MSCI than competitor Refinitiv.

A Liberum analyst has hit out at MSCI over its ESG ratings, calling for investors to ignore sustainability ratings from the firm due to “biases” in its ratings methodology that could lose them money.

In a Substack blog post this morning, investment strategist Joachim Klement cited a recent paper from Bocconi University that found investors that use MSCI ESG ratings may actually lose money compared to other companies.

Last week, Liberum struck a deal with fellow investment bank Panmure Gordon to merge, creating the UK’s largest investment bank focused on smaller and mid-sized firms.

The paper cited by Klement examined the ratings from the perspective of ‘ESG momentum’, meaning companies that have improved their ESG credentials over time, that some investors use when selecting sustainable firms.

In a previous blog post in November, Klement had noted that companies with better share price performance were more likely to receive a strong ESG rating under MSCI than competitor Refinitiv.

He argued that this was likely due to MSCI’s ESG index business, incentivising it to boost the performance of its indexes to make them more appealing to investors.

Now, Klement argued this tactic of trying to boost the past performance of ESG indexes was actually weakening their future performance due to biases towards stocks that had performed well over the last year.

He explained: “Share price momentum tends to fade after about a year or two, so if a hypothetical ratings agency upgrades stocks that have high past share price momentum, they will do so after about a year or so of strong performance.

“Hence, ESG rating upgrades that take past share price performance into account should lead to lower and potentially negative return differentials after the upgrade.”

In contrast, MSCI competitor Sustainalytics saw positive excess returns when stocks were sorted based on ESG momentum.

“As an investor interested in ESG ratings that make sense and help create performance, I would ignore MSCI ESG ratings until I have a clear explanation and understanding of their methodology and use Sustainalytics or Refinitiv data instead,” Klement added.

MSCI has been contacted for comment.