7 costly myths of sustainable investing
Morningstar has introduced the industry's first global standard for portfolio sustainability based on environmental, social and governance (ESG) factors.
To help make sense of the worldwide trend towards sustainable investing, Morningstar has introduced the industry's first global standard for portfolio sustainability based on environmental, social and governance (ESG) factors.
The Morningstar Sustainability Rating for funds is an essential tool for those who want to make sustainability part of how they choose the funds they invest in.
Four possible approaches to incorporating ESG are ESG aware, ESG incorporation, ESG outcome and ESG impact.
In ESG-aware strategies, asset managers make ESG data and analytics available and it’s up to the managers how they use the information. With ESG incorporation, ESG is just one set of criteria among many; while ESG outcome results in a portfolio with better sustainability profiles. An ESG-impact strategy is similar to ESG outcome but also attempts to deliver a positive societal or environmental impact.
Whichever strategy your asset manager – or yourself – uses, be aware of believing any of these seven myths that could impact your investment returns.
Myth #1 Ratings are based solely on a company’s environmental records
A fund's green credentials are just one factor taken into account. What’s important to us is how the companies in a fund are also handling social and governance challenges compared to other companies in the same industry.
Social factors may include a labour standards, gender and diversity polices, community and engagement, and treatment of employees.
Governance factors include political contributions, lobbying activities and executive compensation.
Myth #2 Sustainable investing is a vague concept
The framework developed by Morningstar’s analysts and research leaders applies a rigorous objectivity to the process which means that funds which indulge in "greenwashing" are excluded.
This framework examines accepted ESG factors together with Morningstar’s comprehensive data on the investments that funds hold in their portfolios plus company-level ESG information from Sustainalytics.
Myth #3 Sustainable investors sacrifice higher returns
By looking at the sustainability of a fund's holding it's possible to identify funds that may offer a competitive advantage over the long run. While at the same time avoiding those with holdings that may present greater risks as a result of unsustainable choices. This means it is possible to invest in a way that reflects your values while simultaneously finding long-term value in the market.
Exhibit 1. Examples of ESG issues
Myth #4 Sustainable investing restricts your investment options
By offering Sustainability Ratings for more than 20,000 funds globally for investors who want to consider sustainable strategies within their portfolios, there is now an expanded universe of funds to choose from.
Myth #5 Serious investors avoid sustainable investing
Globally, there is more than US$21.4 trillion in assets invested sustainably and 71 per cent of individual investors are interested in the topic. The CFA Institute, the premier global association for investment management professionals, says evaluating ESG issues "will likely lead to more complete investment analyses and better informed investment decisions".
Women, millennials, and generation Z investors (born from the mid-1990s to early 2000s) all express strong interest in sustainable investing, indicating that sustainable investing has the potential to grow into a major component of the market.
Exhibit 2. Different interests. A high percentage of women and millennials say they are interested in ESG investing. Financial advisers aren't responding yet
Myth #6 A fund needs an explicit sustainability strategy in place
All funds are measured the same way, that is, based on the holdings in their portfolios not whether the fund labels itself sustainable. This means that many funds that do not market themselves as sustainable may also receive a high Morningstar Sustainability Rating.
Myth #7 Fund companies pay for a sustainability rating
Morningstar does not accept payments from asset-management firms to rate their funds. Like our other ratings for funds and stocks, this rating is 100 per cent independent. This means you can count on us to report on what a fund actually does, not what the fund company says it does.
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Roger Balch is a contributor for Morningstar Australia.
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