What is the Morningstar ESG Commitment level?

-- | 20/11/2020

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Karen Wallace: ESG funds have gained a lot of traction with investors in the past few years. And no surprise—there are more ESG funds out there than ever before. With an increasingly crowded landscape, investors looking for an ESG fund want to know if ESG concerns play a central role in buy and sell decisions or whether they're barely considered at all. Morningstar analysts have developed a new assessment that helps investors answer this question and more. I'm here with Alyssa Stankiewicz, an analyst on Morningstar's Manager Research team, to discuss Morningstar's new ESG Commitment Level.

Alyssa, thanks for being here.

Alyssa Stankiewicz: Thank you so much for having me.

Wallace: Alyssa, you and your team do very extensive evaluations of funds' resources and strategies. Can you discuss some of the high-level findings that have come out of your research?

Stankiewicz: One thing we expected is that the level of quality varies really widely. Some funds take a rigorous in-depth approach to integrating ESG. Others may be labeled ESG, or sustainable, but really do very little. One surprise was just how many asset managers don't label themselves ESG but do regularly consider those factors. In many cases, managers cite sustainability as a helpful lens for understanding financially material risks and opportunities. So, this ESG Commitment Level was designed to provide investors a really clear understanding of the ESG fund landscape. Currently, most investors are dependent on marketing materials to sift through different approaches to ESG investing. But even if that information is trustworthy, it's hard to compare one fund to another. So that's where Morningstar comes in. Our unique position as independent researchers allows us to help investors navigate an increasingly confusing space.

Wallace: I'd like to take a second and discuss that notion of independence. What does that mean?

Stankiewicz: The ESG Commitment Level is specifically geared toward investors and advisors, not the fund managers or firms themselves. As with our Analyst Rating, asset managers have no say in whether we consider them in our reports. So, we as analysts are under no pressure to give a good or bad rating to a fund. We develop our own opinions through our research. And because we're independent, we can be really transparent about those opinions.

Wallace: And what are some of the criteria that analysts look for when determining a fund's Commitment Level? What makes a Leader?

Stankiewicz: It starts with the fund's ESG philosophy, but then it's backed up by the resources they're committing to the effort, how strong the process is for considering and integrating ESG in the fund, and then how active the team is about engaging with portfolio companies on sustainability issues. A lot of it is actually very similar to how we look at funds for the Analyst Rating: You want to know how strong a fund's strategy is, that the team is well supported in carrying that out, and that the process is robust enough to deliver consistently strong portfolio. Often, the best performers on ESG have developed really thorough proprietary frameworks for evaluating companies. And once a company makes it into the portfolio, they're active about engaging with company management, to ensure they're making progress on sustainability issues. Some fund managers actually have a policy that requires them to sell out of a company if they're not making enough progress.

Wallace: What would be the flip side of that? What would be some characteristics of a fund that you would give a Low score to?

Stankiewicz: In some cases, you'll see a fund that's labelled sustainable or ESG, but once we start digging into the resources and the process backing that up, we find they're really not doing much at all. The portfolio managers may look for ESG opportunities, but there may not be any actual minimum criteria or firm guidelines to make sure the portfolio reflects the ESG mandate. Some of these are pretty obvious: You wouldn't expect an ESG fund to have huge holdings in the oil and gas industry. So, if a fund does, that's something we want to take a closer look at. It's also worth noting that because we'll eventually extend the ESG Commitment Level to all of the funds in our coverage universe, some funds that we think really highly of from a financial perspective might receive a Low or Basic ESG Commitment Level. Some funds just make it clear that ESG isn't part of their process, and that doesn't necessarily mean the fund won't perform well. So that's why we've kept the Analyst Rating separate from the ESG Commitment Level.

Wallace: That's a good point. Alyssa, how should investors use this Commitment Level alongside the Morningstar Analyst Rating or the Morningstar Sustainability Rating?

Stankiewicz: It's important to note that the ESG Commitment Level is completely separate from our other ratings. If a fund is a Leader, which is the top ESG Commitment Level, that doesn't mean they'll receive an upgrade or a medal in the Analyst Rating. The Analyst Rating seeks to identify funds that will outperform the category index in terms of financial return or alpha. The ESG Commitment Level is designed to identify funds that have stronger or weaker approaches from a sustainability perspective. And the way this differs from the Sustainability Rating, or the "globe rating," is that that's really based on the companies that are currently in a fund's portfolio. So, it's more of an aggregate of those companies' sustainability scores, and it's not as forward-looking as this ESG Commitment Level.

Wallace: Alyssa, thank you so much for being here to discuss this ESG Commitment Level. Not all ESG funds are alike, and this rating really helps investors go under the hood to find funds that take the smartest and most thoughtful approaches to ESG investing. Thank you so much for being here to discuss it.

Stankiewicz: Thank you so much for having me.

Wallace: For Morningstar, I'm Karen Wallace. Thanks for tuning in.

This report appeared on www.morningstar.com.au 2020 Morningstar Australasia Pty Limited

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