At Capital Group, using third-party data is only the beginning of how we monitor potential and current investments. All holdings are reviewed against third-party ESG scores to identify potential ESG risks. Then we draw on our investment professionals' deep knowledge and understanding of the investment to determine if the issues are material, how they are being addressed, and how we will act on that information.

Capital Group looks at environmental, social and governance (ESG) concerns when deciding on potential investments. In 2020, we outlined how ESG is explicitly integrated into our investment process, The Capital System℠, via three elements designed to complement each other: research, engagement and monitoring.

The monitoring element of our investment process involves reviewing all our holdings against third-party ESG scores and norms to identify potential ESG risks that merit further investigation. We then draw on our investment professionals’ deep knowledge and understanding of the investment to see if the issues flagged by the third parties are material, how the issuer is addressing them and if any additional action is warranted.

The monitoring stage ensures that we are being systematic in our approach to ESG. It also guards against confirmation bias by introducing external data systematically and ensures we aren’t only seeking out or favoring information that reinforces already-held beliefs. Monitoring our investments against thirdparty data adds an element of objectivity to our ESG integration process.

What are our monitoring criteria?

Capital Group uses six criteria when monitoring equity and corporate debt issuers against third-party data. We have different methodologies in place that cover sovereign, securitized and municipal debt; these will be examined in future publications.

The criteria for corporates include norms-based screening. In other words, investments are screened based on how well they adhere to the social norms embodied by the United Nations Global Compact. Any company that a thirdparty data provider scores as “fail” raises a red flag to us, and we investigate the issue further.

Our process also leverages MSCI and Sustainalytics data. We look at the overall ESG scores provided by each data source, the extent to which the two sources agree, and how a corporate scores on the MSCI governance indicator. We have identified specific thresholds for each indicator that help us flag issues that are most likely to be material.

Monitoring criteria

For equities and corporate fixed income investments, we use two data providers (MSCI and Sustainalytics) and six different scoring methods, illustrated in this table.²

Importantly, our investment in technology has enabled us to implement this process at scale. On a monthly basis, we monitor all our corporate holdings to ensure that changes in scores from third-party data providers are quickly identified.

How accurate are third-party ESG scores?

On the surface, ESG scores from different providers appear to be similar. For example, both MSCI and Sustainalytics consider an issuer’s exposure to industryspecific ESG risks and how well they are being managed. Some commentators have compared ESG scores to credit ratings.

However, a recent study by MIT Sloan School of Management found a correlation of just 0.61 between the major providers.³ Correlation measures the strength of a relationship between two variables: a correlation of 1 means there’s a strong positive relationship, –1 that there’s a strong negative relationship and 0 means no relationship. A correlation of 0.61 shows that major providers’ scores have a relatively weak relationship with each other. In comparison, credit rating agencies share a more reliable and stronger correlation of 0.92.

 

1. Source: Capital Group

2. Note: A separate process is employed for monitoring of sovereigns, municipal bonds, structured products and private corporates. Source: Capital Group, MSCI, Sustainalytics

3. Berg, Florian, Kölbel, Julian and Rigobon, Roberto. 2019. "Aggregate Confusion: The Divergence of ESG Ratings." MIT Sloan School Working Paper 5822-19, MIT Sloan School of Management, Cambridge, MA

 

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