In a potentially feel-good, do-well move Russell Investments has redesigned its environment, social and governance (ESG) scoring process to pin down bottom-line, company-specific ‘material’ factors.
In a paper released last week, Russell says back-testing of its tailored ESG rating system shows investors could “gain an additional 22 basis points (versus using the traditional ESG score)”.
The recut Russell scoring system – which overlays metrics from the Sustainability Accounting Standards Board (SASB) and research house Sustainalytics – considers “only those [ESG] issues that are financially important to a company”.
Authored by Russell quant analyst, Emily Steinbarth, and equity strategy director, Scott Bennett, the study found many of the traditional ESG factors are irrelevant to particular company performance.
“Specifically, for 66% of all securities in the Russell Global
Large Cap Index universe, less than 25% of the data items in the traditional score are considered material,” the report says.
For example, the study says that rating an investment bank on fuel efficiency was hardly relevant while for an airline the measure was critical.
“This explains why using fuel efficiency as a signal across a universe could lead to inconclusive results, even though it may be a valid signal for a subset of the universe,” the paper says.
The new Russell ESG measure maps the 30 industry-level SASB ‘materiality’ factors against Sustainalytics’ 145 ESG sub-category matrix to create bespoke company scores.
“At roughly 65% correlation, our new material scores are indeed positively correlated— but, meaningfully different—from the traditional scores,” the report says. “This indicates that the Russell Investments scores offer something extra and above that of the traditional scoring approach.”
Russell will kick-off real-life use of the refined ESG scoring process in its decarbonisation strategy, the paper says, with further applications likely.
“We believe that the Russell Investments’ material ESG score represents a strong development in our understanding of ESG performance drivers,” the report says. “Today, the scores are being used and measured in our research databases to help us chart further progress.”