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New Ratings Reveal Who's Serious About Sustainability

ESG Commitment Levels help investors find the right strategies and asset managers.

As more and more mutual funds carry a “sustainable investing” label, the challenge for investors is how to tell whether environmental, social, and governance questions are central to a sustainable fund’s strategy or if they are just one factor among many.

These questions are big ones for sustainable investing. Many investors in ESG funds have made that choice because they want their money to have an impact on the world outside of their portfolio.

The Sustainable Investor's Tool Kit With this in mind, Morningstar is introducing a new qualitative measure, the Morningstar ESG Commitment Level, which classifies strategies and asset managers on a four-tiered scale: Leader, Advanced, Basic, and Low. These new ratings will be gradually rolled out for the strategies and asset managers that receive Morningstar Analyst Ratings (our Gold, Silver, Bronze, Neutral, and Negative ratings). Morningstar Direct and Office clients can find our whitepaper with the new ratings on strategies and asset managers here.

The ESG Commitment Level ratings come in addition to the tools that Morningstar already offers to help investors find investments that align with their preferences, including the Morningstar Sustainability Rating and the Morningstar Low Carbon Designation. The difference is that while these quantitative measures reflect what’s in a fund’s portfolio and the levels of ESG risks that those holdings carry, the ESG Commitment Level helps investors understand which strategies and asset managers are serious about ESG.

For the new ratings, Morningstar’s analysts consider question such as: Does the firm have a dedicated ESG team, and how is that integrated into the fund’s strategy? What kind of ESG data does it use, and exactly how does it use it? Is the firm a signatory of the UN-supported Principles for Responsible Investment? What kind of ESG proxy-voting guidelines does the firm have, and what is its track record?

The Morningstar ESG Commitment Level is assigned to both asset managers and individual strategies. The asset manager's ESG Commitment Level is factored into the strategy’s because the firm’s philosophy and resources impact how aligned a strategy is to an ESG mandate.

The Leader Board Here's how the ratings break down broadly among different firms.

Leader--ESG is core to their identity. They have long histories committed to ESG investing, and ESG considerations are ingrained and pervasive in their investment processes, strategies, voting records, and in their own operations. For U.S. investors, Calvert and Parnassus fall into that category.

Advanced--Asset managers carrying an Advanced rating are among the industry's better ESG proponents and are deliberate in integrating ESG considerations into investment processes. Nuveen/TIAA is on this list.

Basic--Many of these firms are still in the early stages of ESG incorporation. While others are further along, they aren't developed enough to be classified as Advanced. Some have a well-intentioned approach and dedicated resources, but their proxy-voting records and disclosures are still works in progress. This is the largest group of fund managers and includes BlackRock, American Funds, Pimco, and Wellington Management (which manages a number of Vanguard and Hartford funds).

Low--Firms at this level are typically just getting started on incorporating ESG considerations into their processes, using ESG criteria in a limited or more-variable way, or simply not incorporating ESG at all. American Century, Dodge & Cox, Fidelity, and Vanguard funds land in this group.

A Tale of Two U.S. Equity ETFs Beyond looking a firm's commitment to ESG, the new ratings can also differ at the individual fund level based on the specific strategy. This helps investors to more easily determine which funds match their preferences.

IShares MSCI USA ESG Select ETF SUSA and iShares ESG Aware MSCI USA ETF ESGU are both passive, but they have different levels of ESG Commitment because of differences in the stock screens used for the indexes they follow.

Advanced--iShares MSCI USA ESG Select ETF provides strong exposure to the best ESG-scoring companies in each sector. Most stocks don't make the cut based on their ESG ratings or involvement in controversies or controversial lines of business.

Basic--iShares ESG Aware MSCI USA ETF has a similar process, but a looser approach to ESG criteria in the index it tracks means that the strategy doesn't necessarily avoid all ESG laggards. It owns a fair number of them, including AMZN, Johnson & Johnson JNJ, and JPMorgan JPM, which IShares MSCI USA ESG Select ETF excludes.

What Makes a Leader in Fixed Income ESG Commitment isn't limited to equity funds, so investors don't have to sacrifice sustainability for fixed-income exposure. TIAA-CREF Core Impact Bond TSBIX and Pimco Total Return ESG PTSAX are two funds that have demonstrated a strong commitment to ESG in the core-plus bond space.

Leader--TIAA-CREF Core Impact Bond benefits from the firm's large, centralized ESG team and a lead manager steeped in responsible investing. The strategy incorporates traditional ESG screening alongside more robust rankings and impact investments, making this one of the purest ESG bond strategies out there.

Advanced--Pimco Total Return ESG has adopted a holistic approach to sustainability that takes advantage of the firm's integrated ESG analysis. The portfolio emphasizes issuers with improving-to-exemplary ESG practices while avoiding those with deteriorating-to-harmful ESG traits.

While both strategies have strong ESG mandates, this TIAA-CREF strategy is a step above in terms of management experience and dedicated resources.

ESG Commitment Supports Long-Term Consistency When it comes to quantitative measures based solely on portfolio exposure, strategies can coincidentally have low ESG risk even without pursuing any kind of sustainability mandate. For example, avoiding energy companies because of poor performance can lower a strategy's overall carbon risk. But without ESG commitment, that lower exposure isn't guaranteed. If energy companies rebound, they could easily end up back in the portfolio. A robust ESG framework and the resources to back it up ensure that a strategy will have consistent ESG risk exposure in the long term. The Morningstar ESG Commitment Level helps investors feel confident that an asset manager or strategy is aligned with their views of sustainability, so they have a better sense of how their investments will behave in the future.

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