A Liberum analyst has sharply criticized MSCI for its ESG ratings and urged investors to ignore the company’s sustainability ratings because the rating methodology is “distorted” and could cause them to lose money.

In a Substack blog post this morning, investment strategist Joachim Klement cited a recent study from Bocconi University that found that investors using MSCI ESG ratings can actually lose money compared to other companies.

Last week, Liberum entered into a merger agreement with investment bank Panmure Gordon, creating the UK’s largest investment bank focused on small and medium-sized companies.

The document cited by Klement examined the ratings from the perspective of “ESG momentum,” that is, companies that have improved their ESG credentials over time and that some investors consider when selecting sustainable companies.

In an earlier blog post in November, Klement noted that companies with better share price performance are more likely to receive a strong ESG rating from MSCI than its competitor Refinitiv.

He argued that this was likely due to MSCI’s ESG index business, which provides the company with incentives to boost the performance of its indices to make them more attractive to investors.

Klement now argues that this tactic of boosting the past performance of ESG indices actually weakens their future performance by favoring stocks that performed well last year.

He explained: “Share price momentum tends to slow down after about one to two years. So if a hypothetical rating agency upgrades stocks with strong price momentum in the past, it will do so after about a year of strong performance.”

“Therefore, ESG rating upgrades that take into account past share price performance should result in smaller and potentially negative return differentials after the upgrade.”

In contrast, MSCI competitor Sustainalytics achieved positive excess returns when stocks were sorted by ESG dynamics.

“As an investor interested in meaningful and performance-enhancing ESG ratings, I would ignore MSCI’s ESG ratings until I have clearly explained and understood their methodology and instead use data from Sustainalytics or Refinitiv,” Klement added.

MSCI was asked for comment.