General August 26, 2025

Before the Green Fees: Why ESG Portfolio Management Isn't Straightforward

Unpacking the problem of inconsistent ratings, rising regulation, and performance uncertainty.

By RAIIS Research Team

From the recent working paper: "Green Fees: Sustainability Impacts on Portfolio Management"

Environmental, Social, and Governance (ESG) investing integrates non-financial criteria—such as environmental impact, social responsibility, and corporate governance—into portfolio decision-making, complementing traditional financial metrics. Its growing prominence is shaped by institutional mandates, regulatory developments, and evolving investor preferences.

In Europe, regulatory initiatives have been central to embedding ESG in financial markets. The European Commission's Sustainable Finance Action Plan, alongside the Non-Financial Reporting Directive (NFRD)1 and Sustainable Finance Disclosure Regulation (SFDR),2 requires firms and financial institutions to disclose ESG alignment [1]. SFDR aims to standardize ESG reporting and mitigate greenwashing. Research shows that without strong regulation, corporate sustainability disclosures risk being symbolic rather than substantive [2,3,4].

Further, the European Securities and Markets Authority (ESMA) has issued classification criteria for ESG-related funds [5]. SFDR Articles 8 and 9 require at least 80% of assets to align with environmental or social characteristics as defined in Delegated Regulation Annexes II and III,3 with “Sustainability” funds requiring 50% of those to meet the “Sustainable Investments” definition under Article 2(17) of SFDR. “Impact” funds must meet additional safeguards, including Paris-aligned exclusions,4 and contribute measurably to environmental or social goals [6]. Studies document investor preference for funds with higher ESG ratings and clearer labeling, supporting increased inflows into Article 8 and 9 funds [7,8,9].

While ESG regulations aim to enhance transparency and prevent misleading claims, portfolio managers face challenges due to the absence of standardized ESG scoring methodologies [10,11]. Reliance on EU taxonomy data is limited, as few companies are mandated to report taxonomy alignment, and NFRD reporting only became mandatory in 2023, complicating compliance with ESMA classifications. As a result, managers often use ESG ratings as proxies due to resource constraints [12,13,14]. However, ESG rating agencies apply divergent methodologies, leading to inconsistent assessments [15] and uncertainty for compliance [16]. Research documents systematic rater effects and biases linked to firm size, geography, and industry [17,18], making asset selection and portfolio construction highly dependent on the rating provider [19].

Figure 1 tracks Spearman rank correlations of ESG ratings from Refinitiv, Bloomberg, and MSCI for firms in the S&P 500, S&P 400, and STOXX 600 from 2014 to 2024. The Spearman rank correlation captures the monotonic association between two ESG rating providers rankings of the same companies and is invariant to scale and other monotonic transformations of scores . Higher values close to +1 indicate strong agreement, values near 0 little shared ordering and negative values near -1 indicate opposite rankings. Persistently low, flat lines signal sustained disagreement.

ESG Rating Correlation Analysis (Figure 1)

Interactive correlation analysis - Spearman rank correlations of ESG ratings across major indices

Interactive features: hover for detailed values, drag to zoom, double-click to reset view

Correlations remain persistently low, consistent with prior studies reporting average values from –0.10 to 0.75, depending on providers and metrics. For the S&P 500, correlations—especially those involving MSCI—decline over time, suggesting growing divergence in large-cap ESG assessments. In contrast, S&P 400 mid-cap correlations strengthen, with MSCI converging toward the others. The STOXX 600 shows overall stability but declining correlations between MSCI and both Refinitiv and Bloomberg between 2018 and 2022. These patterns suggest that increased ESG disclosure over the past decade has not led to consistent rating convergence. Rather, more disclosure may introduce divergence as agencies apply proprietary methodologies to interpret malleable information. When disclosure is limited, agencies often rely on similar heuristics, but as data expands, methodological differences become more pronounced. The distinct trends across indices likely reflect the interplay of these opposing forces across market segments.

Empirical studies find that such rating disagreement (as visualized in Figure 1) often signals higher perceived risk and expected return [20,21], though its effect on portfolio-level performance remains ambiguous. Horn and Oehler (2024) [22] report divergent holdings across rating providers but no consistent differences in risk-adjusted returns. Similarly, De Spiegeleer et al. (2020) [23] observe that rating constraints shift allocations in major indices but do not always result in systematic return differences. Beyond selection effects, maintaining ESG-aligned portfolios entails significant transaction costs due to frequent rebalancing to meet ESG targets amid rating and market changes [24].

ESG Performance and Rating Disagreement

The question of whether ESG integration improves or hinders returns remains unresolved. Some studies find positive performance effects, particularly during periods of strong ESG sentiment or fund inflows [10,25,26,27], while others report neutral or negative impacts, noting ESG constraints may limit access to profitable opportunities in certain market conditions [28,29,30,31,32]. Variation in findings has been attributed to timing, market segments, and ESG strictness [22,33,34].

Overall, evidence indicates that while ESG rating choices influence portfolio composition and risk perceptions, their impact on risk-adjusted returns is less clear. Moreover, existing research emphasizes performance metrics without fully addressing operational costs of ESG implementation. Specifically, the transaction costs required to maintain ESG alignment amid market and rating changes remain underexplored.

The RAIIS founders' Green Fees study addresses this gap by evaluating ESG scores as practical proxies for sustainability integration in portfolio management, particularly under growing regulatory pressures and persistent EU taxonomy data limitations.

Implications for Portfolio Management

Key challenges facing portfolio managers include:

  • Rating Provider Selection: Choice of ESG data provider significantly affects portfolio composition and compliance with regulatory requirements.
  • Regulatory Compliance: Meeting regulatory requirements with limited taxonomy data availability.
  • Performance Attribution: Distinguishing ESG effects from other factors in portfolio performance analysis.
  • Transaction Costs: Managing costs associated with maintaining ESG alignment as ratings and market conditions change.

Conclusion

Before implementing ESG constraints, portfolio managers must navigate the fundamental challenges of inconsistent ratings, evolving regulations, and uncertain performance impacts. The persistent disagreement among major ESG rating providers, combined with limited standardized reporting data, creates significant operational challenges for portfolio construction and regulatory compliance.

While ESG integration continues to gain momentum, driven by regulatory requirements and investor demand, the practical implementation remains complex. Portfolio managers must carefully consider their ESG data sources, understand the implications of rating disagreements, and account for the operational costs of maintaining sustainability alignment in dynamic market conditions.

References

[1] European Commission. (2018). Action Plan: Financing Sustainable Growth. Communication from the Commission to the European Parliament.

[2] Marquis, C., Glynn, M. A., & Davis, G. F. (2014). Community isomorphism and corporate social action. Academy of Management Review, 32(4), 925-945.

[3] Kim, A., Kim, Y., An, N., Harley, J., & Malatesta, D. (2015). Environmental and economic performance in the U.S. electricity industry. Strategic Management Journal, 36(11), 1711-1729.

[4] Marquis, C., Toffel, M. W., & Zhou, Y. (2016). Scrutiny, norms, and selective disclosure: A global study of greenwashing. Organization Science, 27(2), 483-504.

[5] ESMA. (2024). Guidelines on funds' names using ESG or sustainability-related terms. European Securities and Markets Authority.

[6] European Commission. (2019). Regulation (EU) 2019/2088 on sustainability‐related disclosures in the financial services sector. Official Journal of the European Union.

[7] Huang, H. H., Kerstein, J., & Wang, C. (2020). The impact of climate risk on firm performance and financing choices. Journal of Finance, 75(3), 1467-1522.

[8] Ammann, M., Bauer, C., Fischer, S., & Müller, P. (2019). The pricing of ESG risks in corporate bonds. Working Paper.

[9] El Ghoul, S., Guedhami, O., & Kim, Y. (2021). Country-level institutions, firm value, and the role of corporate social responsibility initiatives. Finance Research Letters, 41, 101620.

[10] Dimson, E., Marsh, P., & Staunton, M. (2020). Divergent ESG ratings. Journal of Portfolio Management, 47(1), 75-87.

[11] Kotsantonis, S., & Serafeim, G. (2019). Four things no one will tell you about ESG data. Journal of Applied Corporate Finance, 31(2), 50-58.

[12] Scalet, S., & Kelly, T. F. (2010). CSR rating agencies: What is their global impact? Journal of Business Ethics, 94(1), 69-88.

[13] Chelli, M., & Gendron, Y. (2013). Sustainability ratings and the disciplinary power of the ideology of numbers. Journal of Business Ethics, 112(2), 187-203.

[14] Van Duuren, E., Plantinga, A., & Scholtens, B. (2016). ESG integration and the investment management process: Fundamental investing reinvented. Journal of Business Ethics, 138(3), 525-533.

[15] Christensen, D. M., Serafeim, G., & Sikochi, A. (2022). Why is corporate virtue in the eye of the beholder? The case of ESG ratings. Accounting Review, 97(1), 147-175.

[16] Widyawati, L. (2020). A systematic literature review of socially responsible investment and environmental social governance metrics. Business Strategy and the Environment, 29(2), 619-637.

[17] Berg, F., Kölbel, J. F., & Rigobon, R. (2022). Aggregate confusion: The divergence of ESG ratings. Review of Finance, 26(6), 1315-1344.

[18] Liang, H., Sun, L., & Teo, M. (2020). Responsible hedge funds. Review of Finance, 25(6), 1585-1633.

[19] Billio, M., Costola, M., Hristova, I., Latino, C., & Pelizzon, L. (2021). Inside the ESG ratings: (Dis)agreement and performance. Corporate Social Responsibility and Environmental Management, 28(5), 1426-1445.

[20] Gibson, R., Krueger, P., & Mitali, S. F. (2021). The sustainability footprint of institutional investors: ESG driven price pressure and performance. Financial Analysts Journal, 77(3), 73-90.

[21] Avramov, D., Cheng, S., Lioui, A., & Tarelli, A. (2022). Sustainable investing with ESG rating uncertainty. Journal of Financial Economics, 145(2), 642-664.

[22] Horn, M., & Oehler, A. (2024). Disagreement in ESG ratings: Implications for portfolio managers. International Review of Financial Analysis, 95, 103568.

[23] De Spiegeleer, J., Höcht, S., Jakusch, S. T., Severiens, S. E., & Staalduinen, M. (2020). ESG: A new dimension in portfolio allocation. Working Paper.

[24] Auer, B. R., & Schuhmacher, F. (2016). Do socially (ir)responsible investments pay? New evidence from international ESG data. Quarterly Review of Economics and Finance, 59, 51-62.

[25] Edmans, A. (2011). Does the stock market fully value intangibles? Employee satisfaction and equity prices. Journal of Financial Economics, 101(3), 621-640.

[26] Lins, K. V., Servaes, H., & Tamayo, A. (2017). Social capital, trust, and firm performance: The value of corporate social responsibility during the financial crisis. Journal of Finance, 72(4), 1785-1824.

[27] Albuquerque, R., Koskinen, Y., & Zhang, C. (2019). Corporate social responsibility and firm risk: Theory and empirical evidence. Management Science, 65(10), 4451-4469.

[28] Pástor, Ľ., Stambaugh, R. F., & Taylor, L. A. (2022). Dissecting green returns. Journal of Financial Economics, 146(2), 403-424.

[29] Hong, H., & Kacperczyk, M. (2009). The price of sin: The effects of social norms on markets. Journal of Financial Economics, 93(1), 15-36.

[30] Bolton, P., & Kacperczyk, M. (2021). Do investors care about carbon risk? Journal of Financial Economics, 142(2), 517-549.

[31] Engle, R. F., Giglio, S., Kelly, B., Lee, H., & Stroebel, J. (2020). Hedging climate change news. Review of Financial Studies, 33(3), 1184-1216.

[32] Chava, S. (2014). Environmental externalities and cost of capital. Management Science, 60(9), 2223-2247.

[33] Pástor, Ľ., Stambaugh, R. F., & Taylor, L. A. (2021). Sustainable investing in equilibrium. Journal of Financial Economics, 142(2), 550-571.

[34] Pedersen, L. H., Fitzgibbons, S., & Pomorski, L. (2021). Sustainable investing in equilibrium. Journal of Financial Economics, 142(2), 572-597.

Footnotes

1 Directive 2014/95/EU.

2 Regulation (EU) 2019/2088.

3 Commission Delegated Regulation (EU) 2022/1288.

4 Regulation (EU) 2020/852.

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Disclaimer: This research blog and the linked paper are provided for informational purposes only and does not constitute investment advice. Past performance does not guarantee future results. All investments carry risk of loss.