Millennial investors tend to incorporate sustainability into their decisions, with sustainable investing having increased by more than 33 per cent to $9 trillion, from $6.57 trillion, since 2014, according to the Morgan Stanley Institute for Sustainable Investing.

The 2017 survey polled 1,000 active individual investors about their interest in sustainable investing, showing a greater demand for investments that can have a positive social and environmental impact.

Almost 90 per cent of millennials are interested in sustainable investments that could be customised to respond to their interests and goals. It also found 75 per cent of this investor segment believe their investments may influence climate change.

  • 84 per cent of respondents believe their investment decisions may help lift people out of poverty.
  • 61 per cent have took at least one sustainability-related investment action last year.
  • 90 per cent are interested in pursuing sustainable investments as part of their pension saving.

Pyrford International--part of Bank of Montreal's investment arm BMO Global--is among various fund managers noticing this trend. "We've looked closely at this, because it has a financial impact: if you dump stuff in the river, employ 9-year-olds in Bangladesh, or have lousy corporate governance, then it will hurt your P&L, and so it should," says Tony Cousins, Pyrford's CEO.

"The funds management industry, 20 years ago, used to turn a bit of a blind eye to this sort of stuff, and now they can't."

"[The younger demographic] have a real conscience about this stuff. In the past, it was just disinvestment--if you didn't like something a company, you'd just sell the stock. That's totally changed, it's all about engagement," he says.

Tobacco companies are a prominent example of a segment that "wouldn't have changed if they hadn't been put under pressure to do so. If you're providing capital, you can change behaviour at companies".

Cousins says certain clients of Pyrford expect them to act in concert with other investors to change the behaviour of companies, "and this comes from the younger folk, who care about this stuff".

Dealing in death

In this regard, he also highlights a discrepancy between Australia and his home country, the UK, with Australia the only market where investors effectively can't own shares in tobacco companies.

"A lot of UK local government pension funds are agonising over this…if these weren't very powerful financial models, it would be a no-brainer. But these are very high-powered…the best performing stock in the S&P 500 is still Phillip Morris, because these are staggeringly cash-generative.

"And when you go and visit a tobacco company, the first thing you do is you come out and you shower. Because they're selling an addictive product that kills you, and these are ruthless people, but they are very successful, and they've shown remarkable financial discipline in how they've invested money.

"But in our industry, the pendulum has swung more to say [delivering shareholder value] is your job, but you also have to take these other things into account as well," he says.

Apart from avoiding exposure to certain types of businesses that have traditionally been highly cash-generative, determining exactly what activities certain businesses are involved with can be challenging.

"Actually finding the details of what companies, such as those in defence, are investing in is difficult," he says--for instance, in companies involved in the manufacture or distribution of munitions such as land-mines and cluster bombs.

Screening for ESG

Morningstar's Sustainability Ratings were rolled out across the global Morningstar group from July 2016, using a methodology created in partnership with ESG ratings specialist Sustainalytics.

This uses a data-driven process to rank investment funds according to their performance against environmental, social and governance (ESG) criteria.

Socially responsible investing has traditionally involved screening out specific companies or sectors from investment portfolios. For instance, by avoiding investing in companies involved in gaming, tobacco, fossil fuels or carbon-intensive industries.

Morningstar adopts a data-driven methodology for "positive screening"; so the end investor can opt to buy shares in companies that meet specific best-in-class parameters.

Exhibit 1 Distribution of Sustainability Ratings in any given category group

Source: Morningstar

Four different scores are assigned to each company. One grades the firm's environmental behaviour, another ranks its social issues activities and another grades its governance systems. These are then combined to generate an overall ESG score.

For example, News Corp's overall ranking around social issues is reduced considerably by its News of the World phone-tapping scandal. This is an absolute grade, unrelated to the individual industry, which Morningstar applies as a deduction from the company's ESG score.

Morningstar then turns these company-level scores into a portfolio-level rating. This is done by generating an asset-weighted average of the ESG scores of companies in the portfolio, minus any controversy deductions.

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Glenn Freeman is a senior editor at Morningstar.

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