What are we looking for?
ETFs and DIY mutual funds with low degrees of ESG risk.
The screen
With a terrible calendar year now behind us and a booming energy market, an unknowing investor might just give up on the concept of sustainable investing. Remember, though, that investing this way doesn’t necessarily mean you must be particularly motivated by personal values and beliefs. In fact, the core of many environmental, social and governance (ESG) risk measures (like Morningstar’s Sustainability Rating for funds) is the concept of materially financial effects caused by non-financial risks. For example, if a manufacturing company has poor corporate policies regarding wage fairness, it may lead to a strike that ultimately affects a company’s bottom line. Hence, regardless of your intent as an investor, risk is always something worth considering before entering a position. Make no mistake: ESG risk is a type of risk. With this in mind, today I use Morningstar Direct to search ETFs and mutual funds available to the DIY investor that have not only outperformed their peers but also exhibit low degrees of ESG risk. To do this, I used two criteria:
(1) A Morningstar Sustainability Rating of five globes (recall that this rating is a time- and asset-weighted aggregate of the Morningstar Sustainalytics ESG Risk rating of individual holdings within a portfolio. Companies that are able to manage their risks through effective corporate policies, relative to global industry peers, will score better on this measure).
(2) A Morningstar Rating for Funds (a.ka. the “Star Rating”), which is an objective lookback at risk-adjusted returns after fees. Our research shows that although the measure is backward looking, on aggregate five-star funds tend to outperform four-star funds and three-star funds after receiving the rating. The star rating is an excellent starting point for further research.
What we found
The funds that meet the above requirements are listed in the accompanying table alongside their categories, MERs, ratings and trailing performance. It is important to note the theme of the screen, as many of the funds listed today are not “intentionally” sustainable. That is, the funds’ investment objectives make no mention of being sustainable, which might be a desirable characteristic for those who wish to invest in line with personal beliefs. Regardless of intentionality, Morningstar seeks to show investors the degree of ESG risk inherent in all funds for investors who still want to monitor the degree of ESG risk inherent in a traditional investment fund.
This article does not constitute financial advice. Investors are encouraged to conduct their own research before buying or selling any of the securities listed here.
Ian Tam, CFA, is director of investment research for Morningstar Canada.
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Ian Tam, CFA