ESG Investing: How Ratings Are Built, Why They Disagree, and What Fund Labels Now Require

ESG investing uses information about a company's environmental record, treatment of people, and governance when deciding what to own, how much, and how to vote. Most investors meet it through a fund built on someone else's ESG ratings, so the useful questions are practical ones: how the ratings are made, why two providers can rate the same company very differently, what a fund must do before it can call itself ESG or sustainable in the US, EU, and UK, what shareholder voting on these issues looks like after the 2026 season, and what the ESG version of an index fund costs.

This guide covers ESG integration and screening in listed markets. Investing to produce a specific, measured outcome, often in private funds, is covered in our impact investing guide. How companies use AI to manage their own ESG risk and reporting is in our guide to AI for ESG risk and compliance.

How ESG ratings are built

A rating provider starts by deciding which issues matter for each industry: emissions and water for a utility, data privacy and labor practices for a software company, product safety for a drug maker. It then gathers data on each company's exposure to those issues and on how it manages them. The data come from company reports and filings, regulatory databases, news and controversy monitoring, and, where companies disclose nothing, the provider's own estimates. Scores for each issue are weighted and combined into an overall rating.

Two common designs give different kinds of answers. MSCI's ESG ratings run from CCC to AAA and rank a company against its industry peers, so an oil producer can earn a high rating by managing its risks better than other oil producers. Sustainalytics' ESG Risk Rating instead estimates the amount of unmanaged ESG risk on an absolute scale, where lower is better, so the same oil producer usually looks worse next to a software company. A fund built on industry-relative scores can hold energy companies that a reader of the fund's name would not expect. Neither design is wrong; they answer different questions, and the fund's index methodology tells you which one it uses.

Ratings also lean on disclosure. Large companies with sustainability teams publish more data and tend to score better, and estimates for companies that disclose little can move sharply when real data arrive.

Why providers disagree

The best-known study of the problem is "Aggregate Confusion" by Florian Berg, Julian Kölbel, and Roberto Rigobon, published in the Review of Finance in 2022. They compared ESG ratings from six providers: KLD, Sustainalytics, Moody's ESG (Vigeo Eiris), S&P Global (RobecoSAM), Refinitiv (Asset4), and MSCI. According to the MIT Sloan project summary, pairwise correlations between the ratings averaged 0.54, while Moody's and S&P credit ratings correlate at 0.92. Across pairs, correlations ranged from 0.38 to 0.71.

The authors split the disagreement into three sources:

They also found a rater effect: a provider's overall view of a company tends to color its scores on individual topics. The practical consequence is that "high ESG rating" is not a single, portable fact about a company. Two ESG funds tracking indexes from different providers can hold noticeably different stocks, and a company can enter or leave a fund when a provider changes its method without the company changing anything.

For an investor, that argues for reading the index rules rather than the fund name. Check which provider's data the index uses, whether it excludes industries outright or reweights within them, how far it lets sector weights drift from the parent index, and what the largest holdings are. As of September 28, 2026, iShares ESG Aware MSCI USA ETF held 269 stocks against 504 for iShares Core S&P 500 ETF, according to the fund pages, so "ESG version of the market" can mean a much narrower portfolio.

What a fund must do to use ESG in its name

The US Names Rule

The SEC's 2023 amendments to the Names Rule extended the requirement to adopt an 80% investment policy to funds whose names suggest investments with particular characteristics, including terms that indicate an environmental, social, or governance focus. A fund must invest at least 80% of its assets in line with its name, review its portfolio against that policy at least quarterly, and generally get back into compliance within 90 days if it drifts. In 2025 the SEC extended the compliance dates to June 11, 2026 for fund groups with net assets of $1 billion or more and December 11, 2026 for smaller groups.

The rule governs names and the 80% basket; it does not define what counts as "sustainable." Each fund defines that in its own policy, so the policy wording is worth reading. The SEC's separate 2022 proposal for detailed ESG fund disclosures was withdrawn in June 2025, so there is no US standard for ESG fund reporting beyond the Names Rule and general anti-fraud law. The SEC has brought greenwashing cases under that general authority, including a $19 million ESG-related penalty against DWS in 2023.

The EU: SFDR now and SFDR 2.0

Under the current Sustainable Finance Disclosure Regulation, funds disclose under Article 6, 8, or 9 depending on whether they promote environmental or social characteristics (Article 8) or have sustainable investment as their objective (Article 9). These were designed as disclosure categories, but the market treated them as labels.

The reform known as SFDR 2.0 would replace them. The European Commission proposed three voluntary product categories on November 20, 2025: Sustainable, Transition, and ESG Basics, each requiring at least 70% of the portfolio to meet the category's criteria. The Council agreed its negotiating position in June 2026, and the European Parliament's ECON committee adopted its position on September 10, 2026. According to Travers Smith, a plenary vote was expected in early October, after which the three institutions negotiate the final text; the 70% threshold appears likely to survive. As of September 2026 the law is not final, the category criteria may still change, and the new rules would apply 18 or 24 months after the final text takes effect, depending on which institution's timeline is adopted.

The UK: SDR labels

The UK Financial Conduct Authority's Sustainability Disclosure Requirements include four optional labels for UK funds: Sustainability Focus, Sustainability Improvers, Sustainability Impact, and Sustainability Mixed Goals. The FCA's guidance requires at least 70% of a labeled product's assets to be invested in line with its sustainability objective, measured against an evidence-based standard. Funds without a label face limits on using terms like "sustainable" or "impact" in their names, and an anti-greenwashing rule applies to all regulated firms.

Uptake has been modest. LSEG Lipper counted £40.32 billion in SDR-labeled funds at the end of June 2026, 85.5% of it under the Sustainability Focus label. Labeled funds had net redemptions of £2.84 billion in the first half of 2026; Sustainability Improvers was the only label with inflows, £298 million.

In the US, Morningstar reported that sustainable funds took in $3.0 billion in the second quarter of 2026, their first quarterly inflow after 14 quarters of outflows, and held a record $398 billion.

Proxy voting in 2025 and 2026

Owning shares comes with votes, and for ESG investors voting and engagement are often the main way to influence companies. The 2026 season showed a sharp drop in environmental and social proposals. ISS-STOXX counted 275 E&S proposals submitted to US companies as of June 30, 2026, about 43% fewer than the 482 submitted by the same point in 2025, and 162 reached a ballot. None received majority support, compared with five the year before. Climate was the most common topic, and political spending proposals drew the highest average support.

Cooley's review of Russell 3000 companies put average support at 16% for environmental proposals and 15% for social ones, against 34% for governance proposals and 5% for proposals from anti-ESG proponents. ISS's recommendation made a large difference: environmental proposals it backed averaged 33% support, against 14% when it opposed them.

The rules are changing too. In November 2025 SEC staff stopped giving substantive responses to most requests from companies to exclude proposals, and in August 2026 stopped responding to them at all. On September 16, 2026, the SEC proposed rescinding Rule 14a-8, which would leave shareholder proposals to state law and company bylaws. The comment period runs 60 days after publication in the Federal Register, and Rule 14a-8 stays in force unless and until a final rule is adopted, so it still governs proposals for most 2027 annual meetings.

If voting matters to you, check how your fund votes. Large fund companies publish their voting records on Form N-PX and their voting policies online, and some index managers now let fund investors choose among several voting policies for their share of the fund's votes.

What ESG index funds cost

ESG versions of index funds usually charge more than the plain versions they are built from, although the gap has narrowed. Expense ratios from the fund pages as of September 2026:

Illustration: $100,000 invested for 20 years at an assumed 7% annual return before fees grows to $384,804 in a fund charging 0.03% and $376,262 at 0.15%, a difference of $8,542. Between SPY and EFIV the difference is $391. Fees are the smaller issue. Because an ESG index holds a different set of stocks, its return can differ from its parent index by far more than the fee in any year. If the ESGU-style fund trailed its parent by 0.5 percentage point a year, the same $100,000 would end at $342,570; if it led by 0.5 point, $413,086. Neither is a forecast. The point is to judge an ESG fund by its tracking difference against the parent index over several years, alongside its expense ratio.

For investors who want exclusions without a packaged ESG fund, direct indexing lets you own a broad index and remove specific companies or industries yourself, and our index fund guide covers choosing the plain version.

Checking an ESG fund before you buy

1. Read the fund's 80% policy and index methodology. Find out whose ratings it uses, whether it excludes industries or only reweights within them, and how far its sector weights can drift from the parent index.
2. Look at the top holdings and sector weights. If they are nearly identical to the parent index, you are paying extra for a small tilt; if they are very different, expect returns to differ too.
3. Compare the expense ratio and several years of tracking difference against the plain index fund from the same company.
4. Check how the fund manager voted on E&S proposals in its latest Form N-PX filing or voting report, if voting is part of your reason for buying.
5. If you want a measurable outcome rather than a better-rated portfolio, look at impact investing instead.
6. In a taxable account, remember that an ESG index with more turnover can realize more gains; our tax-efficient investing guide covers fund tax efficiency.

A fee-only adviser can help match a fund's methodology to what you actually care about; see our guide to choosing a financial advisor and our breakdown of wealth management fees.

This guide is for informational purposes only and does not constitute investment, tax, or legal advice. Fund fees, holdings, and regulatory status are as of September 2026 and can change; SFDR 2.0 and the proposed rescission of Rule 14a-8 are pending. The illustrations use assumed returns, not forecasts. Consult qualified professionals before investing.