Recent Morningstar research shows that the number and size of U.S. sustainability funds continues to grow.  Notable recent additions include sustainable exchange traded funds (ETFs).  Within this universe is a wide variation in strategies and commitment—from considering environmental, social and governance (ESG) alongside other factors, to integrating ESG in the investment process, to impact and green economy-focused funds.  

A growing body of academic research shows that sustainability leads to better business practices and superior investment returns.  Even where sustainability is not explicit in a fund’s purpose, providers of investment instruments are integrating ESG into traditional investment strategies to protect portfolios against new risks and even against general market downturn.  

In 2016, Morningstar released the Morningstar Sustainability Rating as a way for investors to compare funds on how well their holdings perform on ESG issues relative to peers.  The 2018 release of the Morningstar Carbon Risk Score further expands the range of fund-level sustainability metrics.

In addition to holdings-based ESG analytics, fund investors also want to know how their fiduciaries are stewarding their investments.

The addition of proxy voting to Morningstar’s sustainable investing metrics later in 2019 will provide another way to compare funds and fund managers on sustainability.  Indexed proxy voting data, when combined with Morningstar’s fund holdings and securities data, will give investors the tools to trace issues and votes to holdings and vote outcomes, thereby affording a new level of transparency to previously opaque and non-standardized disclosures.  

Increasingly, fund investors understand the connection between how their retirement savings are invested and their social impact. 

How the managers of retirement investments vote on senior executive pay and on shareholder initiatives addressing climate change, for instance, has real implications for fund investors’ quality of life.  Investors’ own retirement funds could well be used to oppose changes that, as citizens, they strongly support—like political spending disclosure.  

In June 2019, E.U. member states will have implemented the amended Shareholder Rights Directive (SRD II).  SRD II encourages asset owners and asset managers to more effectively exercise their stewardship responsibilities.  Enhanced disclosure standards include the requirement that managers reflect on how stewardship policy contributes to sustainability.  The emphasis on sustainability as a stewardship obligation of investment fiduciaries will likely drive global standards in proxy voting and engagement.

Asset managers who’ve deployed their beneficiaries’ retirement savings across the length and breadth of markets are under pressure from both investors and regulators to show that these funds are being voted and mobilized behind a purpose that goes beyond profit.  Furthermore, the increasing concentration of funds in passively-managed vehicles offered by very large managers means that there are few alternative strategies for avoiding material ESG risks that could impact significant portions of the market.  

Stewardship via proxy voting and engagement are therefore becoming core investment functions within the largest asset managers and stewardship teams and expertise are expanding.  

The power to make informed choices amongst funds based on how their managers vote proxies and how they advocate on ESG issues extends to fund beneficiaries and asset owners a degree of ‘voice’ inherent in their investments.

Jackie Cook
Director of Sustainable Stewardship Research, Morningstar

Jon Hale
Global Head of Sustainability Research, Morningstar