MSCI/ESG ratings: grade deflation should pump box tickers’ profits

Environmental, social and governance investing has been a source of huge growth for the asset managers. Total investment in sustainable funds reached $2.5tn last year — a 290 per cent increase from 2018, according to Morningstar.

ESG investing has also been a boon for companies that produce the ratings that determine which stocks ESG funds can buy. The biggest of these is MSCI, the New York-based index group.

Morgan Stanley reckons some 60 per cent of assets parked in US ESG ETFs are linked to MSCI’s ratings. The company has been under pressure for the quality of its ESG scores. Critics have accused it of grading on a curve. In response, MSCI is poised to unveil an overhaul of its methodology that would strip hundreds of funds of their ESG ratings and downgrade thousands more.

It is a smart business move, even if it does not make spotting genuinely ethical companies easier. The lack of universal standards for ESG investing is one problem. Another is that there is no single regulator.

But for MSCI, ESG has become an important growth engine. Group operating revenues grew 10 per cent to $2.2bn last year while net income rose by a fifth to $870mn. Within this, the ESG and climate segment delivered revenue growth of 37 per cent to $228mn, compared to the low single-digit gains recorded by its bigger index and analytics divisions. It boasts a chunky operating profit margin of 53.7 per cent. MSCI’s share price has increased 277 per cent in five years. The stock now trades on 43 times forward earnings.

Rivals have noticed. The biggest credit rating agencies, FTSE Russell and Bloomberg, are among those competing to sell ESG ratings and data to money managers. MSCI is therefore aiming to position itself as a “best in class” ESG provider, both for indexing and ratings.

ESG investing will remain controversial, with critics branding it shallow, box-ticking and self-contradictory. But consequent regulatory attempts to curb greenwashing should ultimately be good for MSCI’s business.

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