This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on March 7 - 13, 2016.

Morningstar Inc has introduced the industry’s first sustainability rating for 20,000 global funds. The Morningstar Sustainability Rating for funds will enable investors across the world to assess how well the companies held in mutual and exchange-traded funds are managing their environmental, social and governance (ESG) risks and opportunities.

In a March 2 press release, Morningstar Benelux CEO Steven Smit, the newly named head of sustainability, said that given the growing interest in sustainable investing around the world, investors need better tools to help them determine whether the funds they own or are considering adding to their portfolios reflect the best sustainability practices. 

“Our Sustainability Rating and related metrics will provide investors with an ESG lens they can use to evaluate funds and, eventually, other managed products ... This initiative will help us better serve investors who place particular importance on incorporating ESG factors into their investment decisions.”

According to the press release, the Morningstar Sustainability Rating “helps investors gauge how well the companies held in a fund are managing the ESG issues most relevant to their industries and compare funds across Morningstar categories and against benchmarks. Morningstar calculates the rating based on the underlying fund holdings and company-level ESG research and ratings from Sustainalytics, a leading independent provider of ESG and corporate governance ratings and research”.

The Morningstar Sustainability Rating calculation involves a two-step process. First, each fund with at least 50% of assets covered by a company-level ESG score from Sustainalytics receives a Morningstar Portfolio Sustainability Score — an asset-weighted average of normalised company-level ESG scores, with deductions made for companies involved in controversial incidents, such as environmental accidents, fraud or discriminatory behaviour. 

Then, funds receive sustainability ratings of low, below average, average, above average and high, illustrated with globes — a low rating is one globe while a high rating is five globes. Morningstar assigns ratings to all funds that have more than half their underlying assets rated by Sustainalytics, not just funds with explicit sustainable or responsible investment mandates. 

Of the 20,000 funds covered by the Morningstar Sustainability Rating, data shows that only 10% received five globes, followed by 22.5% with four globes. The majority of companies (35%) received three globes, 22.5% received two globes and 10% received one globe.

Morningstar’s initial analysis of the ratings reveals that “funds with explicit sustainable or responsible mandates are generally practising what they preach”. “Nearly two out of three such funds received the highest ratings — more than double the percentage of funds with sustainability ratings overall. It is important to note that funds with explicit sustainable or responsible investment mandates comprise about 2% of the fund universe.”

Morningstar has made the ratings and related ESG metrics available on Morningstar Direct, its research platform for asset managers and wealth management professionals, and Morningstar Office — the company’s practice management system for independent financial advisers. In the coming weeks, Morningstar will launch the ratings on other platforms, including Morningstar Advisor Workstation and Morningstar.com, as well as other websites around the world.

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