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Large-Growth Medalists at the Extremes of Sustainability

Quite a few good large-growth funds earn high Sustainability Ratings despite not being explicitly ESG-oriented.

David Kathman, CFA, 05/31/2016

The Morningstar Sustainability Rating for Funds is designed as a tool for investors who are interested in sustainability, in addition to more-traditional investment criteria. The rating, which we rolled out in March, measures funds on a variety of environmental, social, and governance (ESG) criteria, such as environmental and workplace policies, product safety, and corporate responsibility, and also dings companies involved in controversies, such as Volkswagen's (VOW) recent emissions scandal. Funds with a Sustainability Rating of High (represented by 5 globes) have holdings that collectively score very well on ESG factors, while funds with lower scores earn lower ratings, down to Low (represented by 1 globe).

Since introducing the Sustainability Rating, we've done some preliminary studies to see how the rating correlates with other investment factors. Not surprisingly, funds that explicitly commit themselves to sustainability as part of their mandate tend to have high Sustainability Ratings, with 80% earning ratings of Above Average or High. We also found that Morningstar Medalists (funds with a Morningstar Analyst Rating of Gold, Silver, or Bronze) tend to have modestly higher Sustainability Ratings than the universe as a whole. We also looked at some of the funds in each Morningstar Category that earn the highest Sustainability Ratings, whether or not they're consciously ESG-oriented.

In this article, we'll drill down in more depth into the large-growth category and the Sustainability Ratings of individual funds, with a focus on Morningstar Medalists. The following table shows the large-growth medalists with Sustainability Ratings of High or Low, the two extremes. In addition to each fund's Morningstar Analyst Rating and Sustainability Rating, we also show the elements that go into the Sustainability Rating. Each fund gets separate ratings for environmental, social, and governance factors (where High is best and Low is worst), and these are combined into an overall ESG rating. Each fund also gets a Controversy score, which measures its exposure to risks from controversies; this is deducted from the ESG score (with a High Controversy score causing the biggest deduction, a Low score the smallest deduction) to get the fund's Sustainability Rating. (See the Sustainability Rating Methodology document for all the details on how the rating is calculated.)

Out of the 48 large-growth medalists, the only one with an explicit ESG focus is Bronze-rated Neuberger Berman Socially Responsive NBSRX, though Bronze-rated Amana Growth AMAGX, primarily a religious fund that adheres to Islamic principles, also has many secular ESG features. Both of these funds earn Sustainability Ratings of High, meaning that they do what they promise in terms of ESG and sustainability. Beyond these funds, though, there are quite a few good large-growth funds that earn high Sustainability Ratings despite not being explicitly ESG-oriented, and other funds that score low on sustainability despite being attractive in other ways.

The most notable large-growth funds to earn high Sustainability Ratings are a quartet managed by the Primecap team: Vanguard Primecap VPMCXVanguard Primecap Core VPCCXVanguard Capital Opportunity VHCOX, and Primecap Odyssey Growth POGRX. All four of these funds earn Analyst Ratings of Gold and Sustainability Ratings of 5 globes (High), meaning they're among the cream of the crop by both measures. The Primecap managers have never used any explicit ESG screens in running those funds, but they do a lot of research and typically own quality companies they can hold for a long time. For years they've had big overweightings in technology and healthcare, two sectors that are not as likely as some others to be involved in controversies.

The Primecap funds are the only large-growth funds that combine the highest Analyst Ratings and Sustainability Ratings, but a couple of Silver-rated funds in the category earn a 5-globe Sustainability Rating. One of these is Jensen Quality Growth JENSX, which only holds companies that have generated returns on equity of at least 15% in each of the past 10 years. That means it holds a lot of big, stable growers and avoids highly cyclical names; like the Primecap funds, it's heavy in technology and healthcare, with Microsoft MSFTJohnson & Johnson JNJ, and medical device firm Becton Dickinson BDX among the top holdings. The other Silver-rated 5-globe fund in the category is ClearBridge Aggressive Growth SHRAX, which has been managed for more than 30 years by Richie Freeman (with Evan Bauman as his comanager since 2009). Like the Primecap and Jensen funds, it's heaviest in healthcare and technology stocks, which together make up nearly 60% of its most recent portfolio.

Five Bronze-rated large-growth funds also earn the top Sustainability Rating. In addition to the above-mentioned Neuberger Berman Socially Responsive and Amana Growth, there's also MFS Massachusetts Investors Growth Stock MIGFXVulcan Value Partners VVPLX, and Franklin Growth FKGRX. The MFS and Franklin funds, like the others we have just seen, have big weightings in technology and healthcare stocks, though the Franklin fund has an even bigger stake in industrials, including several airlines and railroads. Vulcan Value Partners, on the other hand, has about 90% of its portfolio in four sectors--financials, consumer cyclicals, industrials, and technology--though like the others, it holds primarily quality stocks with good free cash flows and strong balance sheets.

David Kathman, CFA, is a senior fund analyst with Morningstar.

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