Climate ratings for investment funds: do they show the full picture?

A new climate change metric, Climetrics, which aims to rate investment funds on a scale of one to five ‘leaves’, has been launched today.

The ratings consist of an analysis of the underlying fund holdings (this part makes up 85 per cent), the investment policy of the fund and mandate (which makes up 5 per cent), as well as the public statements companies make and the agreements they sign up to (the remaining 10 per cent).

We asked Climetrics to name the saints and sinners – and while disappointingly they refused to disclose the sinners – the funds with the highest 5-leaf rating include: EdenTree Amity International, EdenTree Amity Global Equity Income Fund for Charities, Rathbone Global Opportunities, Stewart Investors Worldwide Sustainability, and Liontrust SF Global Growth.

But how comprehensive are ratings like these which aim to measure the impact of funds? While ‘the principle of such metrics sounds fine, it’s the execution which is often the problem,’ says John Ditchfield, partner at Castlefield. He adds: ‘How do they score a bank financing coal or shale gas?’

Ratings are often skewed towards bigger companies because they produce more data

He compares these metrics with the Morningstar Sustainability Rating, which aimed to decide whether companies have good environmental, social and governance (ESG) practices, but was in fact skewed towards bigger companies such as Shell – because they produce more data on their ESG practices, than smaller, environmentally friendlier companies.

‘They were trying to apply an analytical model for something that doesn’t easily adapt,’ says Ditchfield, when ‘you have to try and understand what companies are really doing.’

In addition to favouring large caps, ESG ratings can also favour those companies that are most likely to have a negative impact on society. Because given that come companies have the biggest ‘negative impact challenges’ they will try to introduce good ESG practices in other parts of the business.

Tobacco companies, for instance, tend to have extremely well-developed policies on how they manage their workforce, so therefore are likely to score well on ESG ratings.

There is a crucial difference between ESG, sustainability and impact

Crucially, there is an important difference between ESG, sustainability and impact when it comes to evaluating investments: ESG practices tend to relate to how companies run their business, such as their internal carbon footprint.

Second, sustainability addresses how a company manages their business internally as well as the product they produce.

And finally, measuring impact is the most holistic approach, which requires the intention to generate positive social and environmental outcomes in the long run.

Therefore, a tobacco company might rank well in ESG ratings because it has a low carbon footprint, but it’s not sustainable or impactful. Similarly, a bank which finances coal mining or shale gas might have good occupational practices, but again, it would not be sustainable or have a positive impact in terms of where it invests. 

Here's what the top ten holdings of a fund can reveal

Looking at the top ten holdings in the MW Old Mutual Newton Global Income fund – which is one of the saints according to Climetrics – there are two tobacco companies.

George Latham, managing partner of Wheb Asset Management, adds: ‘I think we need to be careful about how we use the word impact as it risks confusing the audience if it’s used in broad ways.

‘If we take holistic view to sustainability in relation to climate change, then it’s important to consider what products are doing to address climate change, and not just the processes within companies. We would like to see a more holistic analysis in the marketplace.’

Climetrics was created and backed by the Carbon Disclosure Project (CDP), ISS-Ethix Climate Solutions, and Climate-KIC, the European Union's climate innovation initiative. Paul Dickinson, executive chair at CDP, says: ‘Investors in funds will be aware of their funds’ climate impact and can judge investments accordingly.’

We asked Climetrics to explain the inclusion of funds which have tobacco companies among their main holdings.

Maximilian Horster, managing director at ISS-Ethix Climate Solutions and Steven Tebbe, managing director of Europe at CDP respond that ‘some tobacco firms are quite good on deforestation and how they think about running large plantation factories’. This, however, does not address the fact that they are running plantation factories which produce tobacco products.

It's a competition to top rather than a race to the bottom

They add that the rating does not explicitly rate companies that try to mitigate climate change. Instead, ‘we shine a light on these companies, and highlight the ones that are doing better than the others, we try to promote competition to top rather than a race to the bottom.’

Funds which explicitly invest in sustainable, renewable energy, such a Pictet Water, are not necessarily included in the ranking because they are ‘specialist’.

Instead, ‘the funds in the ranking are not perfect’, the ranking simply aims ‘to help a retail investor who walks into a bank, wants to invest in one of many global equity products see which might be better than the other’.

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