(PUB) Investing 2016

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Using Our New Sustainability Ratings Morningstar Research | Jon Hale

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

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. 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 Found at Morningstar.com, our rating is a measure of how well the companies in a fund’s portfolio are