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Many people are interested in sustainability today but
are finding it hard to apply the concept to their own
investments. Sustainable investing generally refers to
the incorporation of environmental, social, and gover-
nance, or
ESG
, considerations into an investment
process. The new Morningstar Sustainability Rating for
funds can help you incorporate sustainability into your
own portfolio.
Found at Morningstar.com, our rating is a measure of
how well the companies in a fund’s portfolio are
managing their
ESG
risks and opportunities relative to
other funds in the same Morningstar Category. The
company-level data come from Sustainalytics, an
ESG
research firm. The rating assesses companies based
on the most material and influential
ESG
issues they face
in their industries, and it penalizes firms involved in
serious controversies—such as the
Volkswagen
VOW
emissions scandal. The company-level ratings are
rolled up on an asset-weighted basis to calculate a
portfolio score. Ratings are then assigned relative to a
fund’s Morningstar Category.
There are many reasons why investors are interested in
sustainable investing. Some may wish to see their
portfolios more closely reflect their personal values.
Others may want to make a societal or environmental
impact with their investments by joining like-minded
investors in allocating their capital to companies that
better manage the sustainability challenges those firms
face. In so doing, these “impact” investors are doing
their part to support the companies that are leading the
way to a more sustainable global economy.
Regardless of whether an investor wants to make a
statement or have an impact, he may be, at heart,
a traditional value-driven investor who recognizes that
companies that better manage the
ESG
risks and
opportunities they face could make more-attractive
long-term investments. That’s the way many asset
managers and large institutional investors see it.
Many of the world’s largest asset-manage-
ment firms have incorporated
ESG
factors into their
investment processes over the past few years.
Let’s take a look at how funds in the Morningstar
500
fare on our measure of sustainability. A little over
300
of them receive ratings. These are mostly large- and
mid-cap equity funds and a smattering of allocation
funds. Our initial ratings don’t include many small caps
or a way to evaluate sovereign debt, so not many
small-cap funds or bond funds have ratings.
The Sustainability Ratings of these
305
funds are dis-
tributed about the same way as the overall universe.
About one third have Sustainability Ratings of
4
or
5
globes, another third merit
1
or
2
globes, and the rest
have
3
globes. The M
500
funds that have Sustain-
ability Ratings of
5
globes appear to be a higher-quality
set than those with
1
-globe ratings, and the relation-
ship is pretty linear in the
2
- through
4
-globe groups.
Two thirds of the funds with the top Sustainability
Rating (
5
globes) have Morningstar Ratings of
4
or
5
stars, meaning they’ve turned in strong risk-adjusted
performance relative to their peers. Nearly that many,
62%
, have Gold or Silver Morningstar Analyst Ratings,
meaning that our analysts have a high level of convic-
tion that the funds will outperform their peers over
the long run. Contrast that with funds that have the
lowest Sustainability Rating (
1
globe). Only
34%
have Morningstar Ratings of
4
or
5
stars, and
31%
have Gold or Silver ratings. Keep in mind, however,
this doesn’t demonstrate a causal link between
sustainability and performance because our Sustain-
ability Rating doesn’t go back in time.
Lower Risk/Lower Turnover/Higher Quality
There are several traits we may expect to see among
funds that have better Sustainability Ratings. The
first is lower risk, but a very specific form of risk. Incor-
porating
ESG
factors into the investment process
can be an effective risk-management tool because it
can identify nonfinancial risk factors that may not
appear in traditional analysis. Second is a longer-term
investment horizon. The
ESG
factors may some-
times affect short-term earnings, especially when a
Using Our New Sustainability Ratings
Morningstar Research
|
Jon Hale