Ratings of investment funds on ESG factors – trend solidifying

In mid August research firm Morningstar Inc said it plans to score mainstream mutual funds and exchange-traded funds on environmental, social and governance factors, reflecting growing attention to the issues among investors.

Morningstar of Chicago said Thursday it will start scoring mutual funds later this year based on the ESG ratings of companies held in fund portfolios. The ESG ratings will be provided by Sustainalytics, an Amsterdam research firm. Sustainalytics has provided ESG research and analysis for more than two decades. The company focuses on relevant ESG issues within industries and across markets, assigning each company under coverage approximately 70 indicator-level scores related to environmental impact, social practices, and governance policies and procedures

Morningstar plans to eventually provide ESG scores for a broad range of funds with holdings including stocks and corporate bonds and sovereign debt. MorningStar is not the first research house to incorporate ESG ratings into research, as others have been doing this for decades. However, it appears to be the first to do it for whole portfolios, ETFs and mutual funds. And, as one of the world’s largest research analytics distributors, it is influential.

Investors are placing increasing importance on environmental, social and governance (ESG) policies and practices. Earlier this year, a Morgan Stanley Institute for Sustainable Investing study showed that 71 percent of individual investors are keen on sustainable investing. The number of financial institutions that have signed the UN-supported Principles for Responsible Investment (PRI) has gone up by 29 percent in one year. According to one report, funds with an ESG tag now total $6.2 trillion in total assets under management.

The message to boards is that ESG practices, and disclosure of these practices, are important. In Australia, influential industry superannuation funds have created headlines by pulling investments from companies that have been subject to ESG issues.

Locally, Regnan has been applying a governance rating system for well over a decade that Goldman Sachs research indicates is well correlated to total shareholder returns. Other research houses have their own in-house ESG rating teams. Last year the private equity owned proxy adviser ISS started using its governance ratings on their Australian proxy advice reports. It has followed this up with the sales of governance rating services to Australian listed companies, accounting and consulting firms through its Singapore based “arms length” corporate business sales unit, and will soon employ a sales person based locally.

However, ESG ratings quality and reliability vary greatly. And the ratings available to listed companies for a fee are not usually the ones used by investors because of the inherent conflicts of interest that would arise. This is not to say that they are not useful to either investors or the boards of listed companies. For the latter they may be a valuable input into identifying sources of risk. But they may in many cases be an unreliable indicator of investor assessment and action, and should not substitute for a company’s own systematic and continuous monitoring of ESG factors and their associated risk.


© Guerdon Associates 2024
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