Morningstar is to change its sustainability ratings methodology, which allows investors to evaluate funds based on the sustainability profile of their underlying holdings, by the end of the year.
The ratings create an overall ESG score via company ratings provided by Sustainalytics, a provider of corporate environmental, social and governance (ESG) research, ratings and analysis.
The current system awards companies ‘globes’ on a range of ESG criteria and there has been criticism from small/mid cap firms – which might have a high environmental score but a low governance score due to limited resources – that they receive an unduly low overall score.
Morningstar’s head of sustainability Steven Smit told Expert Investor that the group intended to address this issue.
“We always said when we launched this two years ago, the methodology would look different in a couple years, and by the end of the year it will look different. The philosophy and basics will not change but we’ll make enhancements,” he said.
“Some funds by nature are very sustainable but we only hand out one or two globes. [Therefore] we are changing the categorisation of the funds.
“[In the future] lower scoring but sustainable funds will be rolled into larger peer group categories to give a better reflection of how each fund is doing in terms of sustainability.”
Difficulty in measuring sustainability
Smit also said that they would measure the last 12 months of the funds’ performance rather than the current portfolio.
“I think that will address some of the criticisms… but some things are difficult to capture,” he said.
“We cannot measure the immeasurable, so if we can’t get independent data and proof that engagement is happening and that it is effective, we cannot put these things in an indicator. We are limited by the data that is out there.”
Sustainalytics executive vice president Diedrik Timmer said large companies overall received a slightly higher score compared to smaller companies it was not significant.
“There is a risk in an overall ESG score,” Timmer said. “It is broad so for a company to perform well they need to do well on all facets.”
“The concerns I’ve heard a lot are around intentionality and impact oriented funds.”
Morningstar’s rating system currently uses Sustainalytics data to measure how well companies held by a fund are managing their ESG risks and opportunities compared with similar funds. Only funds with at least 50% of their assets that have a company-level ESG ratings by Sustainalytics will receive a Morningstar sustainability rating.
The rating system gives funds a score from one to five globes, with five being the highest score.
Morningstar and Sustainanalytics recently launched the Morningstar Portfolio Carbon Risk Score rating that assesses the carbon risk embedded in a portfolio by analysing both an unmanaged operations risk and an unmanaged products and service risk.
