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Scope ESG says an absolute approach allows impact investors to assess corporates across sectors. However, it is a challenging one, partly because it shows how crucial it is to include analysis of corporate supply chains for which data are partial at best.

“The absolute approach makes relative comparisons fully redundant if we can undertake a holistic assessment of corporate impacts over the life cycle of produced output,” says Bernhard Bartels, director at Scope ESG. “The aggregation of benefits and costs to society express the net impact that investors are ultimately after. However, this holistic ‘value-to-society’ approach requires more comparable data and objective assessments of contribution value,” Bartels says.

In Europe, there is some progress in this area. The new EU Taxonomy provides a description of sustainable environmental activities in an absolute sense while technical thresholds for transitional activities are set relative to sectoral leaders, all amid efforts by Brussels to standardise reporting on environmental, social and governance (ESG) factors across companies.

In contrast, the most-used provider of sustainability ratings predominantly measures the sustainability of companies in relationship to others in the same sector.

Such “best-in-class” assessments are good for detecting which players are leading the way in meeting common ESG challenges through sector-specific technological advances, efficiency gains or sustainability policies.

Take the hypothetical case of a coal-based electricity utility investing heavily in renewable energy to change its business model. The utility is making a more positive net contribution to the environment than a competitor whose environmental impact – whether adverse or favourable – is static. Such assessments provide a potentially useful guide for investors to measure relative contributions to transformation.

“The problem is that sustainability itself cannot be compartmentalised - whether our focus is looking at the impact of corporate activities on the environment and society at large or the ESG-related risks that a company faces - particularly in the long term given that risks are linked to the impacts,” says Bernhard Bartels, director at Scope.

First, “best-in-class” assessments ignore the overall ESG impact of a particular sector. For instance, integrated oil & gas companies (IOCs) such as Royal Dutch Shell and Total SE have high sustainability ratings from one leading ESG-rating provider, which, while arguably merited in comparison with other IOCs, leaves them, somewhat incongruously, as highly rated as Siemens Gamesa Renewables, a Spain-based wind-turbine manufacturer.

“The problem is not with the rating – but the nature of relative ESG scoring,” says Bartels.

Secondly, best-in-class measures ignore absolute sectoral impacts, which remain important considerations for impact-oriented investors who want to avoid some activities in their portfolios. In addition, industrial “peer groups” are broadly defined while impacts within a given sector can differ widely, for instance in manufacturing. Also, large corporates are often structured as conglomerates with multiple business segment activities.