The Morningstar Sustainable-Investing Framework
Clear terminology leads to greater understanding of an evolving area.
Sustainable investing has grown significantly as more investors have become increasingly concerned about the many sustainability challenges facing the world today. Investors are concerned about the impact of climate change and other environmental, social, and corporate governance issues on their investments, and they are concerned about the broader impact of their investments on the world.
To many investors, however, the world of sustainable investing can be a confusing mix of terms and approaches. That’s because of a lack of consensus over terminology and, perhaps more significantly, because sustainable investing does not represent a single, distinct investment approach. Rather, it consists of a range of approaches that have been evolving over the past decade, as asset managers and wealth managers adapted these approaches in unique ways to their existing investment processes. These developments have proceeded largely without regulatory guidance in most of the world, although regulators in the European Union have taken some recent steps in the direction of clarifying terms and the scope of the field. As a result, investors have been left largely on their own to figure out the many facets of sustainable investing.
Morningstar’s Sustainable Investing Framework addresses the critical need for clarity in the field. It provides a straightforward way to understand investor motivations for seeking sustainable investments and outlines the range of activities associated with sustainable investing.
Let’s begin with a definition:
Sustainable investing seeks to deliver competitive financial results, while also driving positive environmental, social, and corporate governance outcomes.
First and foremost, sustainable investing is investing. It is not activism. It is about taking into account the issues and crises facing the world today that are having an impact on investments, and doing so in a conscious and systematic way that aims to improve investments.
Second, sustainable investing considers the broader systemic impacts of investments on the world. Sustainable investors are pushing companies to make net-zero emissions commitments, and encouraging them to address material ESG risks. They are urging companies to shift to purpose-driven, stakeholder-centric business models, not to reduce profits and shareholder returns, but to help them take a more sustainable path to being a profitable business over the long term. Sustainable investors are well-aligned with other stakeholders in these pursuits.
While “sustainable investing” is the umbrella term we use in the Framework, “responsible investing,” “ESG investing,” and “impact investing” are also used more or less interchangeably to describe the same set of investment approaches. “Responsible investing” is an older term, shortened from “socially responsible investing,” or SRI, which was used in the late 20th century to describe the forerunner to today’s sustainable investing. “ESG” is easy to use, especially by investment professionals, but is jargony and better suited to describe the issues that are of concern to sustainable investors and the related metrics that have become so widely used. “Impact” is better suited to describe the part of sustainable investing that emphasizes the broader effects of investments on people and planet.
Our Framework MAP--for Motivations, Approaches, and Portfolios--covers three key dimensions of sustainable investing, organized in an easy-to-understand way that can be quickly grasped by a range of investors.
What is motivating investor interest in sustainable investing?
We know that many investors today have sustainability concerns across a range of ESG issues. A growing number of investors have these concerns--and the concerns themselves appear to be growing--especially around climate change.
Perhaps the best way of thinking about it is to consider what happens prior to the investment context: Investors, whether they are individuals or institutional decision-makers, are people, and more people in the world today have sustainability concerns.
They are expressing those concerns more often in the decisions they make--in other words, focusing on the systemic impacts of their decisions--be they consumer choices, career decisions, or location and lifestyle choices. It should come as no surprise that those who are fortunate enough to be investors or who have the responsibility of being investment decision-makers on behalf of others increasingly want to apply a sustainability lens to their investments.
They want to do so because they believe applying a sustainability lens to their investments can both improve their investments and improve the world. For investments, a sustainability lens can help control risk, and it can help identify new investment opportunities. For the world, a sustainability lens can help investors avoid contributing to negative outcomes and help advance positive outcomes for people and planet.
The assumption that sustainable investing is a single unified investment approach has led to confusion and a mismatch between investor expectations and investment outcomes. It is more accurate to say that sustainable investing covers a range of approaches that are used to apply a sustainability lens to investments.
Thus, we have identified six distinct approaches and placed them along a continuum ranging from those that lean more toward avoiding negative outcomes, be they investment or real-world outcomes, to those that lean more toward advancing positive outcomes.
Investors can address sustainability concerns by applying exclusions, limiting ESG risk, seeking ESG opportunities, practicing active ownership, targeting sustainability themes, or assessing impact:
- Applying Exclusions--Refers to excluding issuers based on certain products/services, an industry, or certain corporate behaviors, like major controversies.
- Limiting ESG Risk--Refers to using ESG information, usually in the form of ESG ratings of companies, to assess material ESG risks as part of the overall assessment of risk.
- Seeking ESG Opportunities--Refers to using ESG information to identify companies that are sustainability leaders, often by industry or sector, or to identify improving companies, or those that are using sustainability to establish or enhance a competitive advantage. This approach includes what is sometimes called "ESG Best-in-Class" or "Positive Screening" based on ESG ratings.
- Practicing Active Ownership--Refers to seeking positive ESG outcomes via active ownership activities, primarily made possible because asset managers are shareholders in public companies. These activities may include:
- Targeting Sustainability Themes--Refers to identifying investments that stand to benefit from the long-term trend toward greater sustainability in the way we live and work. Such themes may include environmental-related themes like renewable energy, clean tech, and clean water, or those related to social themes, such as gender equity, managing population growth, or health and well-being.
- Assessing Impact--Refers to integrating impact assessments into security selection and portfolio construction. Fixed-income managers, for example, may consider a bond's use of proceeds, focusing on bonds that finance projects to benefit people and planet. Equity managers may consider whether a company's products/services/behaviors support or detract from the UN's Sustainable Development Goals, which many investors and companies are using as an impact framework. At the portfolio level, investors may assess the overall impact of their portfolio holdings in relation to a goal or benchmark.
In the real world, sustainable investors often combine these approaches, as they are interrelated and largely complementary. It is not uncommon to observe an investment strategy in which sustainability plays a leading role using several, or even all, of these approaches to varying degrees in its investment process.
In any given portfolio, fund, or investment strategy, these six sustainable investment approaches may play no role, a supporting role, or a leading role. While the approaches play no role for many funds, they contribute in a supporting role to a growing number of funds, mainly by “limiting ESG risk” or “practicing active ownership.” Funds for which sustainability plays a leading role often combine several, or even all, of these approaches.
For investor portfolios that consist of multiple underlying investment strategies or funds, the framework can be used to target exposure to the approaches most preferred by the investor and can be used to evaluate how much exposure an investor has to each approach.
Our framework neatly defines and summarizes sustainable investing, providing investors of all types a common reference point for understanding its scope and variety. It can be used to better understand investor motivations, identify the most-appropriate sustainable investments for a given investor, and evaluate sustainable funds and portfolios.
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The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.