Probability & Partners: The rise of fast ESG scores
By Manos Ieronymakis, Quantitative Consultant at Probability & Partners
In today’s rapidly evolving financial landscape, ESG factors have become critical in evaluating corporate sustainability. Traditionally, these factors have been assessed using slow-moving ESG scores, primarily derived from company-reported data. This includes annual (sustainability) reports and regulatory filings.
These slow scores offer a comprehensive, long-term view of a company’s ESG performance. However, they come with certain limitations. Examples of these are timeliness of the reports and the potential for biases in self-reporting, which could hide the real-time challenges and opportunities companies face.
For example, slow ESG indicators typically include metrics such as a company’s carbon emissions, employee diversity, and adherence to governance standards, which are reported annually or semi-annually by the companies themselves. These indicators rely heavily on the data companies choose to disclose, which may not fully reflect current conditions.
The benefits of fast ESG scores
Recently, a new type of ESG score has emerged: fast ESG scores. Unlike slow scores, fast ESG scores are generated in real-time. Using advanced technologies like natural language processing (NLP) and machine learning to analyse large volumes of data from news articles, social media, and other online content, these scores provide immediate insights into public sentiment and emerging issues, offering a dynamic and responsive assessment of a company’s ESG performance.
Fast ESG indicators might include the real-time sentiment surrounding a company’s environmental impact, social policies, or governance practices. These sentiments are captured from media sources, social media platforms, and other sources on the web. These fast indicators can quickly highlight public reactions to events like an environmental accident or a major corporate scandal, often revealing concerns or issues that are not yet visible in slow ESG data.
The importance of fast ESG scores
The importance of fast ESG scores cannot be overstated, particularly when evaluating companies listed on indices like the S&P 500. Our research, which analysed data from these companies over a 17-year period, shows that fast ESG scores are not just a supplement to slow scores: they are crucial in providing a complete picture of a company’s sustainability practices. For example, while slow ESG scores generally capture the steady improvements companies have made in their environmental and social responsibilities, fast scores reveal how these improvements are perceived in real time by the public and the media.
This dual approach to ESG evaluation is particularly important for investors and stakeholders who need to make informed decisions quickly. Slow scores give a solid foundation based on thorough, albeit sometimes outdated, data. Fast scores, on the other hand, can capture shifts in public perception that might indicate emerging risks or opportunities.
This was evident in our analysis of S&P 500 companies, where we found that, despite the initial discrepancy of those two data sources in the early years, the gap between slow and fast scores has been narrowing over time. This trend suggests that companies are becoming more transparent and proactive in their ESG disclosures, aligning more closely with public sentiment.
However, it is crucial to recognize that while fast ESG scores offer immediacy, they also come with volatility. Media and public sentiment can swing rapidly in response to events, and these swings are reflected in the fast scores. Yet, this volatility can be an asset, particularly in identifying short-term risks that might not be captured by the more stable slow scores. For instance, a company might be performing well according to its slow ESG score, but a sudden environmental incident could cause a sharp drop in its fast ESG score, alerting investors to potential reputational risks that might not yet be apparent in the official reports.
The best of two worlds
In our extensive research of S&P 500 companies over the last years, we see that when slow and fast ESG scores are combined, they offer a clearer and more complete picture of a company’s sustainability. Investors, asset managers, and other stakeholders should consider both types of scores when making decisions. Fast ESG scores, especially, are just as important as slow ones because they provide real-time insights into how companies are perceived in their sustainability efforts.
In conclusion, as the financial world continues to prioritize ESG factors, the integration of both slow and fast ESG scores will become increasingly essential. The future of corporate sustainability assessment lies not in choosing one type of score over the other but in understanding how they complement each other to provide a fuller picture. Investors and stakeholders who embrace this dual approach will be better equipped to navigate the complexities of today’s ESG landscape and make more informed decisions that align with both long-term goals and immediate realities.
