Tools available to sustainable investors moved into new territory with the announcement last August that Morningstar would begin providing fund-level ESG scores for global mutual funds and ETFs within the 200,000 managed funds it tracks. Availability in data feeds began in the fourth quarter of 2015, with a wider roll out throughout their software platforms in the first months of 2016.
This is a significant step into new territory and we can expect other major data providers to follow. Information on environmental, social and governance factors is of course collected at the company level. These are material issues that have an impact on company performance. That information, and ratings developed from it, is increasingly used in making investment decisions across the industry. Larger institutional investors can and do research and demand information from their investment managers about how these factors are considered and what the impact on their portfolios is. Investors in mutual funds and ETFs have not had access to any of that information.
At the time of the dot-com bust in the early 2000s, many mutual fund investors were shocked by the extent of losses in their portfolios because they had no idea that their diversified portfolios were actually heavily weighted toward the information technology and communications sectors. Today, information on sector and industry weightings for funds is both expected and visible. That has not been true for ESG factors and now that is beginning to change. Today, an investor concerned about the risk from, for example, workforce practices in global manufacturing industries has no information to assess that risk across a portfolio of funds. Over the next several years, investors should expect and demand access to that type of information just as they can readily assess the industry concentration of a set of funds.
The mechanics of how this is done are important. In Morningstar’s case, company-level ESG ratings on over 4,500 companies provided by Sustainalytics is being combined with Morningstar’s portfolio holdings data to produce asset-weighted composite ESG fund scores.
If you are in the Boston area, I encourage you to join us at a Boston Area Sustainable Investment Consortium (BASIC) event on March 7th to learn more. We will be hosting Jon Hale, Morningstar’s director of manager research for North America and Diederick Timmer, Sustainalytics executive vice president of institutional relations. Jon and Diederick will talk about this implementation and the broader impact of this type of information on manager and fund evaluations by asset owners, advisors, and consultants.
The broader implications are important. This is only a first step. Investors will now have a first-order tool where they previously had none. If the only result is that investors make binary decisions based on a single rating, the impact will be nowhere near the potential. But if investors see this as a starting point for a deeper examination and engagement, and demand that these tools to be further developed and refined, the impact will be much greater. A January article in the Financial Times quotes Sasja Beslik, head of responsible investment at Nordea Asset Management, when it says that “the ratings will “completely change the narrative” of investing, forcing portfolio managers to consider ESG factors”. The article is provocatively titled, “Morningstar ethical rating could cost funds billions”.
This is a space worth watching.