Boohoo highlights shortcomings with ESG products reliance on self-reported data

Summary

UK fast fashion retailer Boohoo saw its share price fall by 1/3 following allegations that workers in its UK supply chain were being paid 3.50 GBP per hour. The Financial Times notes that 20 ‘sustainable funds’ hold Boohoo shares, and that it was recently the largest holding in the Aberdeen Standard Investment employment opportunities fund, ‘which invests in companies with good employment opportunities and practices’.

The article also points out that company ESG ratings can be inconsistent across different ratings agencies. For example, Tesla has an ‘A’ rating from one ESG group but is ranked in the bottom 10% in another, and a MIT study found a correlation of just 0.54 for scores by six different ratings groups.

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Analysis

There are broad issues raised by the Boohoo example around data collection and methodology in the ESG universe. It highlights shortcomings of ESG ratings agencies and fund managers who rely too much on companies to self-report data, vs. having external data that can be independently obtained without company assistance. While company financial reports and audited financial statements are not perfect, they do in general provide a check on the extent that companies can obfuscate these metrics. ESG providers that rely on company provided ESG data are at a disadvantage.

And one methodology challenge facing ESG indices and funds is how to rate companies that may be weak in one factor but strong in others. For example, how to differentiate between an oil company with excellent labor practices, and a low carbon company with poor labor practices? Cases like this raise the question of whether overall ‘ESG’ scores may be too broad to be useful and too inconsistent to credibly deliver on a core purpose of promoting a more ‘sustainable’ world. The criteria deployed by some index providers has proven malleable. The FTSE Blossom Japan Index includes companies such as Cosmos Energy (oil refiner), JXTG Holdings (oil and gas), IPEX (oil and gas) and Japan Tobacco despite a stated purpose of “supporting capital markets in the transition to a sustainable and green economy”. IPEX has one of the highest ESG scores on the index at ‘4’.

Investors need more precise, independent and market-validated tools that can isolate factors that have demonstrable impact on a company’s finances and stock price, as well as their ESG bona fides. Stories like Boohoo and those about large ETFs like Blackrock’s ESG MSCI USA ETF and Vanguard’s ESG fund holding oil/gas companies will continue until robust methodologies is adopted.

It is, however, possible to objectively measure and independently validate company performance on one of the most important ‘G’ issues. The Cyberhedge Cyber Governance Indices provide market-based proof that cyber governance (a core ‘G’ factor that also has ‘E’ and ‘S’ implications) not only matters, but that it is externally measurable and independently validated. Highly ranked companies (those that do a good job managing technology risks) consistently outperform lower ranked companies within every sector and overall, in every major financial market (US, EU, UK). Utilizing only externally gathered cyber and financial data, this performance has been consistent since the indices launched three years ago.

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Denis Bolshakov

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