A large and growing proportion of global investors are looking for vehicles that take into consideration not only their investments’ financial returns but also the investment capitals’ ability to have a broader societal impact. This trend has propelled environmental, social, and governance (ESG) investing to the forefront of the financial sector. By December 2020, ESG-linked assets had surged to constitute one-third of the $51 trillion U.S. assets under professional management, with predictions suggesting it could surpass $50 trillion by 2025.
It’s Time to Change How ESG Is Measured
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Estimates suggest ESG investing could surpass $50 trillion by 2025, as investors around the world look for opportunities for their investment capital to have a broader social impact. However, research suggests that ESG ratings suffer from a measurement trap that occurs when a metric used as part of the rating is systematically biased towards certain industries or types of companies. This trap can manifest in three ways: 1) The rater focuses on what can easily be measured; 2) The rater overly simplifies the feature to be measured into an existing categorical framework; or 3) The rater tries to distill rich multi-dimensional data into a single number. A two-pronged solution can improve transparency, efficiency, and effectiveness, creating a win-win-win-win scenario for firms, investors, policymakers, and the world more broadly.
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