Morningstar says it is planning sustainable indices with Sustainalytics (Update)

Methodology of sustainable fund ratings comes under attack

Fund research giant Morningstar says it is planning to build on its new sustainable fund ratings offering by launching environmental, social and governance (ESG) indices with its research partner Sustainalytics.

Morningstar introduced the sustainability rating of funds in March using research from ESG house Sustainalytics. Rival MSCI at around the same time expanded its MSCI ESG Research coverage to include mutual funds and exchange traded funds.

“We will launch ESG indexes in collaboration with Sustainalytics,” said Steven Smit, Head of Sustainability at the US giant. “Sustainability ratings are a start and we will grow from there.”

He was speaking at a panel organised by UKSIF where the methodology of fund ratings came under sustained criticism from some leading figures in the ESG community.

Panel member Andrew Howard, the Head of Sustainable Research at funds house Schroders, reiterated the arguments outlined in his recent RI article that fund sustainability ratings are “painting by numbers”.

He said ESG ratings are “an input not an output” in the investment process.Seb Beloe, Head of Research at WHEB, who has also been critical in a previous RI article, quoted H.L. Mencken: “For every complex problem there is an answer that is clear, simple, and wrong.”

But Smit, a former Robeco analyst who is also CEO of Morningstar Benelux, explained that the firm had consulted widely with the market and listened to a lot of feedback. He said: “We stuck out our hand and got it cut off. It is a 1.0 – bear with us.” He went out to say the methodology would be further developed to make it even better.

Morningstar calls the fund ratings “A global standard for sustainable investing”, though in its marketing it stresses they are “not the last word on sustainability”.

Rather they are “an important first step toward providing investors with better tools to evaluate and compare funds based on sustainable investing principles”.

Jon Hale, the firm’s former head of manager research for North America who is now head of sustainability research, said in a recent blog posting: “We’re finding some evidence of a connection between longer-term investing and sustainability performance in our Morningstar Sustainability Ratings for funds. U.S.-based fund managers with longer-term horizons, defined here as those with a portfolio turnover rate of 20% or less, are twice as likely to have the highest Sustainability Ratings than the lowest.”

(Updates with greater context that Morningstar consulted widely.)