Companies are more likely to share information to the public which demonstrates a high commitment to ESG standards. The same companies tend to avoid the disclosure of information that could reflect poorly on corporate practices. As an investor, one can overcome this issue by adopting an ‘outside-in’ approach through the use of alternative data sources.

ESG data can often generate distorted risk signals

The last few years have seen increasing demand from investors and consumers for greater corporate transparency on socially responsible business practices. This is leading many companies to boost marketing campaigns on ESG performance and more frequently disclose the firm’s commitment to sustainability and corporate governance.

ESG ratings agencies commonly integrate voluntary ESG disclosures such as these into their scoring methodologies – some agencies web scrape news articles and other public domains for relevant ESG signals. Many methodologies take into account the volume of positive ESG information, giving these organisations higher ESG scores against industry peers that voluntarily disclose sustainability information less frequently. This is leading to a scoring bias and distorting ESG risk signals.

What’s the solution for users of ESG data?