Morningstar Sustainability Ratings

What is a Sustainability Rating?

Since 2016 investment research firm Morningstar has published sustainability ratings for upwards of 20,000 mutual funds and exchange traded funds. It rates companies on how there perform in the three components of ESG investing, environment, society, and governance. The ratings themselves are given on a five globe system with one being a fund at the bottom of the group, and five globes being an industry leader in sustainability.

The company level ESG scores come to Morningstar from a firm called Sustainalytics. Each company is graded on a scale of 1-100 relative to other firms in its industry. What that means is that just because a firm operates in say, fossil fuels, doesn’t mean they will automatically score poorly. If they make efforts to reduce their carbon footprint, they may be rewarded by receiving a fairly high rating because their rating is only in comparison to other firms in the fossil fuels industry. A score of 50 means a company is average in their industry. A 70 would be two standard deviations above average, with a 30 being two below.

The other factor that Morningstar considers is controversies. Controversies can include things like oil spills, sexual harassment lawsuits, an a host of other events that negatively effect a company.

What these ratings do in practice is provide investors with data that can help them tilt portfolios towards their personal ethics, but avoid using specific ESG branded funds. Because their are some potential shortcoming with ESG funds, some investors may prefer to use traditional funds, but use the globe ranking system to help guide their decision making.