Invest Sustainably for Long Term Returns

Many of the world’s largest companies are now explicitly considering sustainability as part of their long-term business strategies.

Jon Hale, CFA 13.01.2017
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It has been a little over six months since we launched the Morningstar Sustainability Rating for funds, a portfolio-based measure of how well the companies in a fund’s portfolio are addressing the Environmental, Social, and Governance (ESG) issues they face in their businesses. We created the rating because of the rapid growth of interest in the field from the investing mainstream, and because investors who wish to incorporate sustainable investing into their portfolios need a tool to help them evaluate, select and monitor funds.

Many of the world’s largest companies are now explicitly considering sustainability as part of their long-term business strategies. In addition, a growing body of research suggests correlations between better company ESG performance and higher-quality management, higher growth and lower cost of capital. Evidence of positive investor outcomes from sustainable investing are also reported.

As a result, more investors want – and need – insight into the sustainability performance of the companies in fund portfolios because it makes sense to consider these factors from a material, financial standpoint. Of course, many investors also want to align their portfolios with their preference for companies that treat the environment and their workers well, produce safe and useful products, and govern themselves with transparency and a long-term view.

What is Sustainability?
Sustainability is a broad concept that can mean different things to different investors. Our take on a fund’s sustainability – and by implication, a company’s sustainability – is based on how well the companies in a fund’s portfolio are managing their ESG risks and opportunities. Others may wish to focus more on environmental themes or product impact when considering how to incorporate sustainability into a portfolio. That said, both of those considerations are part of the overall ESG evaluations of companies we use in our ratings.

We evaluate sustainability within the context of Morningstar Categories to give investors relevant apples-to-apples comparisons. Because our category system is also based on fund portfolio holdings, it controls for variables like market cap, investment style, and region. Our holdings-based rating does not give extra consideration for good intentions, and funds with some type of sustainability mandate as part of their prospectus are subjected to the same analysis as any other fund. This gives investors a way to evaluate whether a fund is living up to its intentions based on the ESG performance of its actual portfolio holdings.

Naturally, intentional sustainable funds may offer additional benefits that are important to some investors such as engagement in active ownership activities such as proxy voting and direct corporate engagement, a focus on certain ESG themes, greater transparency into how their process works, and perhaps greater ratings consistency over time. For investors in these funds, a portfolio-based rating adds an essential element to the overall evaluation of intentional funds.

How to Use the Morningstar ESG Rating
As a portfolio-based measure, the Morningstar Sustainability Rating is appropriately used alongside other tools and analysis. By itself it does not address performance or describe an investment process, and it does not tell an investor whether a fund is intentionally trying to be sustainable. However, using it alongside other metrics in a due diligence process can help investors evaluate an existing portfolio, select funds and monitor them.

Perhaps most importantly, it can help investors who wish to incorporate sustainability build portfolios of funds. Intentional sustainable funds alone can certainly be a part of such portfolios, but at only two per cent of funds in the global universe, there simply aren’t enough of them to meet the needs of many investors.


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About Author

Jon Hale, CFA  Jon Hale, Ph.D., CFA, is head of sustainability research for Morningstar. 

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