Ethical Investing: What ESG Scores Don’t Tell You

Ethical investing has become one of the fastest-growing trends in the financial world. Investors are no longer only concerned with profits. They also want to know how their money impacts the world. This has led to a surge in the popularity of ESG investing. ESG stands for Environmental, Social, and Governance. These scores are often used to rate how responsible a company is across these three categories. But while ESG scores can be useful tools, they are not perfect. In fact, they often hide more than they reveal. This article will break down what ESG scores really measure and explain what they fail to tell you about a company’s impact.

What ESG Scores Are Designed to Measure

ESG scores are created by financial rating agencies to help investors evaluate non-financial risks. These scores take into account a company’s actions related to climate change, labor practices, executive pay, diversity, board structure, data privacy, and more. Each agency uses its own methodology, and scores are often compiled from hundreds of data points.

In theory, a high ESG score means that a company is managing its risks well and contributing positively to the world. A low score might suggest the company is poorly governed or has environmental or social problems. But in practice, ESG scores are more focused on how these factors impact the company itself than how the company impacts the world.

ESG Scores Focus on Risk to the Company, Not the Planet

One major issue with ESG scores is that they are risk-based, not impact-based. For example, a fossil fuel company can receive a high environmental score if it has strong climate risk disclosures and management systems in place. This does not mean the company is reducing its carbon emissions in a meaningful way. It only means it is managing its risks in a way that protects shareholder value.

This distinction is crucial. A company can be environmentally damaging and still have a good ESG score. That is because ESG ratings are primarily used by asset managers to predict financial performance, not environmental or social outcomes. If a company has systems in place to prevent scandals, lawsuits, or public backlash, its ESG score can remain high, even if its actual practices are harmful.

ESG Scores Are Not Standardized

Unlike credit ratings, which are fairly consistent across rating agencies, ESG scores vary widely. A company might receive an excellent score from one agency and a poor score from another. This is because each agency uses different criteria, data sources, and weighting systems.

Some firms prioritize carbon emissions while others focus on board diversity. Some agencies rely on company self-reporting, while others use third-party investigations. The result is that ESG scores are not always reliable or comparable. As an investor, you could be misled by a score that appears strong but hides serious issues depending on who created it.

Companies Can Game the System

Corporations have become highly skilled at optimizing their ESG scores. Since many ratings rely on self-reported data, companies often disclose just enough information to appear responsible without making meaningful changes. Some firms set vague long-term sustainability goals but offer little detail on how they will achieve them. Others use public relations campaigns to distract from questionable business practices.

This is known as greenwashing. It allows companies to attract ethically minded investors and customers without holding themselves accountable. As a result, investors who rely solely on ESG scores might end up supporting companies that do not align with their values.

ESG Does Not Capture Broader Social Impact

Another limitation of ESG scores is their narrow scope. Many rating systems do not fully account for how a company’s products or services affect society. For example, a weapons manufacturer could receive a solid ESG rating if it operates with good governance and environmental compliance. However, some investors may find the core business itself to be ethically problematic.

Similarly, fast fashion companies might have strong governance structures while contributing to unsustainable labor conditions overseas. ESG scores do not always capture the broader moral concerns that individual investors might care about. This creates a disconnect between what the score suggests and what a company actually does.

How to Go Beyond ESG Scores

If you are serious about ethical investing, you need to dig deeper than the headline ESG ratings. Here are a few ways to do that:

1. Read Sustainability Reports Directly
   Many companies release their own environmental and social impact reports. While these are still self-reported, they often contain more detailed information than a basic score.
2. Use Multiple Rating Sources
   Compare ESG scores from different agencies to get a more rounded view. Look for large differences and investigate why they exist.
3. Understand What the Company Actually Does
   Research the company’s core business model. Ask how it makes its money and what impact that business has on people and the planet.
4. Look at Independent Investigations
   Read news articles, NGO reports, and legal filings that mention the company. These sources can reveal controversies or risks not included in ESG ratings.
5. Consider Values-Based Funds
   Some investment funds go beyond ESG screening and use strict ethical filters. These may exclude industries like tobacco, weapons, or fossil fuels entirely. Look for funds that clearly outline their criteria and offer transparency in holdings.

Conclusion

ESG scores are a starting point, not the final word. They can help you identify some responsible business practices but they also leave out key information. Many scores focus more on protecting companies from risk than protecting people or the planet. They can vary across rating agencies, rely on inconsistent data, and be manipulated through clever disclosures. As an investor who wants to align money with values, you need to think critically and do your own research.

By going beyond ESG scores and asking better questions, you can make more informed and impactful investment decisions. Ethical investing is not just about ratings. It is about responsibility, transparency, and choosing to support companies that truly contribute to a better future.