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3 top-rated sustainable equity funds

Emma Rapaport  |  20 Aug 2021Text size  Decrease  Increase  |  
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The pandemic is far from over, but a silver lining is that it has made people more conscious. Conscious of world events, conflicts overseas, social injustices and the warming climate. For investors, this means more attention to sustainable investments.

Case in point, the data from our latest Sustainable Funds Landscape report indicates that Australia's sustainable funds market is growing at a blistering pace. At the end of the second quarter of 2021, Morningstar estimates that retail assets invested in Australasian sustainable investments were $33.420 billion, a 66% increase compared with 30 June 2020. Last year was also the fifth consecutive year of double-digit fund launches.

But now the hard work comes in. As more and more funds carry a "sustainable investing" label, the challenge for investors is to find a fund that lines up with their beliefs. ESG investing is a personal decision. Investors need to be confident the fund will deliver decent returns and invest in the types of assets they expect.

Today we screen for top-rated sustainable investments that have performed well relative to peers and have strong internal ESG investment processes.

What is ‘Investing Sustainably’?

Investing sustainably is a broad term. It encompasses a gamut of techniques used by fund managers. Morningstar identifies three ‘types’ of sustainable investments:

ESG (environmental, social and governance) funds are a popular type of sustainable investment. A core part of the investment process is to assess the degree of material financial risk connected with environmental, social, and governance issues for a security—like the risk a manufacturer is fined for using sweat shop labour or a coal miner gets slapped with a carbon tax.

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Impact funds typically try to make a measurable difference around areas like the environment, fossil fuels, diversity, and community development.

Environmental sector funds invest in a specific green sector like solar, wind or clean tech.

The below diagram outlines Morningstar's Sustainable Investing Framework.

Sustainable investing

Top-rated funds

We've used Morningstar to screen for sustainable managed funds and ETFs that meet the following criteria:

  • World-class ESG investment processes – the Morningstar ESG Commitment Levelexpresses analysts assessments of individual strategies’ and asset managers’ incorporation of ESG factors into their investment processes and organisations. It is assigned to both strategies and asset managers following a four-tiered scale, from top to bottom as follows: Leader, Advanced, Basic, and Low. 
  • Have a Morningstar medal – The Morningstar Analyst Rating is a forward-looking analyst rating that assesses a fund's ability to outperform in the future. This rating looks at five pillars – people, process, performance, parent and fees.

Investors may also rely on the Morningstar Sustainability Rating and the Low Carbon designation. The former is a quantitative holdings-based measure of a fund’s ESG risks relative to category peers, from one globe to five. It relies on individual company data and assessments from Sustainalytics. The Low Carbon designation is assigned to portfolios that have low carbon-risk scores and low levels of fossil-fuel exposure.

Stewart Investors Wholesale Worldwide Leaders

Stewart Investors Wholesale Worldwide Leaders carries a Gold-Morningstar analyst rating and was one of the top-performing funds during the covid-19 sell-off earlier this year, delivering returns 9.42 per cent above the MSCI World Ex Australia NR index.

ESG is ingrained in all aspects of the investment approach. The team focuses on finding management teams with a shared vision of driving sustainable development. A by-product of this philosophy is that the strategy will not invest in companies with material exposure to harmful products, including weapons, tobacco, alcohol, fossil fuels, and gambling. This vision extends to more-subjective areas, including certain soft drink and snack manufacturers. For example, the team likes Coca-Cola KO because of its independent board, transparency, and efficient water management practices, but it deems the overall product as unsustainable because of its negative health effects, so it focuses the portfolio elsewhere.

The sustainable team is responsible for the vast majority of ESG analysis, and active ownership is part of its toolset to try and improve the sustainability of companies it invests in. The investment team has a long history of engaging with companies, and it is responsible for making all voting decisions, with Edgerton being closely involved throughout the process. Outside of the fundamental ESG analysis, the team works with two external ESG research providers to verify that holdings are not involved in harmful industries or breaching social norms.

Senior Analyst, Christopher Franz

AXA IM Sustainable Equity Fund

Rosenberg Equities, owned by AXA Investment Managers, has a long history of systematic and factor-based investing. Despite struggles in 2020, since inception it has outperformed the MSCI World ex-Australia NR AUD by 0.2% per year, returning 13.7% per year largely due to the strong outperformance in the back end of 2018.

AXA IM has been delivering systematic equity portfolios since the mid-1980s and was one of the first quantitative groups to fully integrate nonfinancial data, such as ESG, into its portfolios. The manager has numerous sectoral policies in place. Controversial weapons, palm oil, and soft commodities are excluded. There are further detailed rules over entities exhibiting climate risk impact, such as a prescribed level of revenue from thermal coal revenue or wattage used by coal-powered energy generation. AXA IM possesses a set of further standards around tobacco producers, weapons manufacturers, companies that breach the UN Global Compact, and overall ESG quality. Breaches to any of these results in termination from the models and portfolios.

AXA IM’s reporting is high quality. Its portfolio visualiser tool allows for the viewing of ESG scores for every stock and the resulting portfolio impact. Its strategy materials further display aggregated data on its major KPIs, together with detail on engagement, proxy-voting statistics, and sustainable development goals.

Senior Analyst, Simon Scott

Australian Ethical Australian Shares

Australian Ethical Australian Share offers a sound approach to ethical investing in domestic equities, particularly when accessed under the reasonable wholesale management fee. However, the high management fee for retail investors is less acceptable. The strategy’s 10 year record is strong, to 30 June 2020, outpacing the ASX Small Ordinaries index, S&P/ASX 300 Accumulation Index and ASX Small industrials index. 

Australian Ethical Australian Shares' investment philosophy and process are concentrated around ESG, ethics, and sustainability. Stocks must pass strict ESG criteria outlined in the 23 principles of Australian Ethical Investment’s Ethical Charter, which includes positive and negative screens. The positive screens direct the portfolio manager toward companies that, in the firm’s assessment, constructively contribute to a better world, including by undertaking activities that add to human happiness, dignity, health, and education. The negative screen results in the strategy avoiding certain stocks and sectors, particularly mining and energy.

The internal ESG and ethical ratings for stocks determine the investable universe. The scores are prepared by Dr Stuart Palmer and the two-analyst-strong ethics research team using input from independent ESG research providers. For the team, ESG analysis is a key part of identifying investment risks and opportunities in stocks well in advance of most competitors. Finally, active engagement, advocacy, and proxy voting are key strengths for the team, rounding out the strategy’s ESG merits.

Senior Analyst, Ross MacMillan

is the editorial manager for Morningstar Australia. Connect with Emma on Twitter @rap_reports. You can email Morningstar's editorial team editorialAU[at]morningstar[dot]com

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