Map: How Countries’ Stock Markets Stack Up on ESG Practices and Carbon Risk

The most sustainable non-European market is Hong Kong, which ranks fourth.

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Amid the market turmoil brought about by the outbreak of the coronavirus pandemic, funds focused on buying stocks that score well on environmental, social, and governance-related metrics proved to be a safer harbor for investors. These sustainable funds had an impressive year in 2020: Three out of four sustainable equity funds beat their Morningstar Category average. And even though the first quarter of 2021 was a challenging one for the performance of sustainable investments, the long-term investment case for ESG remains encouraging: The fact that ESG screens have led to resilience in recent down markets, driven by the relationship between sustainability and attributes like corporate quality and financial health, supports the view that ESG risk is material.

So, how do countries around the world compare on this front? According to the latest edition of the Morningstar Sustainability Atlas, European countries--particularly those in the north--lead the pack in ESG practices. These nations have always been ahead of the curve on ESG, but a few other countries also feature exceptionally strong sustainability profiles. Financial advisors and asset managers can use this data to identify countries with the greatest ESG investment opportunities and most significant risks. Morningstar Direct and Office clients can access the full report here.

The Morningstar Sustainability Atlas uses the constituents of Morningstar country indexes to examine the sustainability profiles of 48 country-specific equity markets. The company-level scores are sourced from Sustainalytics, which also powers the Morningstar Sustainability Rating for funds.

Here, we explore some key findings about the ESG practices of countries around the world.

Portfolio Sustainability Scores: The Netherlands Scores Highest; Emerging Markets Lag

Following suit with previous editions of the Sustainability Atlas, the Netherlands continues to have the world's most sustainable stock market.

Behind the Netherlands, France has overtaken Sweden and Finland for second place in the rankings. This is primarily due to big companies like global producer and distributor of luxury goods LVMH (LVMUY) or electrical equipment supplier Schneider Electric (SBGSF), both classified as ESG outperformers.

Finland ranks third thanks to companies such as Nokia (NOK), a leader within the global technology hardware industry.

The most sustainable non-European market is Hong Kong, which ranks fourth. Insurance company AIA Group (AAIGF)--by far the biggest name within the benchmark--combines low risk exposure with strong management: The company has a strong human-capital development program, and it has established an ESG committee, which includes several senior executives, with responsibility to oversee ESG issues. Taiwan also lands in the first quintile in terms of sustainability, thanks to the big role played by Taiwan Semiconductor Manufacturing (TSM), a global ESG leader.

At the same time, several big Asian markets score poorly on sustainability: Japan and China land in the third quintile and South Korea in the fourth. And a group of Middle Eastern, Latin American, and Eastern European emerging markets, including Russia and Brazil, occupy the globe’s bottom quintile. The full set of rankings is shown on the map below.

Map of Morningstar Country Indexes' Portfolio Sustainability Scores

Source: Morningstar Direct. Data as of Feb. 28, 2021.

The United States, for its part, lands at 13th out of 48. On one hand, companies like Apple (AAPL), Microsoft (MSFT), Berkshire Hathaway (BRK.A), and Visa (V) are considered leaders from a sustainability point of view; on the other hand, the level of ESG risks faced by big names as Facebook (FB), (AMZN), and Johnson & Johnson (JNJ) is classified as "high." This is attributable in most cases to companies' involvement in controversies.

For example, there are serious concerns about Facebook's internal management of Cambridge Analytica's unauthorized harvesting of user data. Facebook has also faced several investigations and lawsuits related to privacy-related allegations, including mining data from users' private messages to sell to advertisers.

Amazon has been linked to incidents regarding poor human rights practices within its supply chain. According to Sustainalytics' analysis, given the high profile of Amazon's human rights breaches in multiple markets, the company is at risk of reputational damage, which may have a negative effect on the company's sales. If the company does not address the ongoing forced labor allegations, a potential supply-chain disruption could pose a threat to its core operations and, furthermore, could affect the company's goods from entering key markets that have strict regulations on permitting goods linked to forced labor to enter their borders.

Countries With The Lowest Carbon Risk: Switzerland, the Netherlands, Denmark, U.S.

Another important consideration is climate change, which might threaten companies' physical assets or business models. They may be affected by policy or regulation aimed at lowering greenhouse gas emissions, their fossil fuel assets may be stranded, or changing popular perception may damage their brands. We use the Carbon Risk Score to assess the degree to which corporate value is at risk from the transition to a low-carbon economy.

Western European markets like Switzerland, the Netherlands, Denmark, Belgium, France, and Sweden carry the lowest Carbon Risk Scores, as does the U.S. In fact, a low level of U.S. stock market value is at risk from the transition to a low-carbon economy because of its technology and healthcare tilt and minimal exposure to energy and utilities.

On the flip side is Russia: With nearly 55% of its market cap in energy stocks, it has the world's highest Carbon Risk Score. Energy-heavy markets like Poland and Czech Republic also carry significant carbon risk. The full set of rankings is shown on the map below.

Map of Morningstar Country Indexes' Carbon Risk Scores


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