Key Takeaways
- Rates funds on ESG risk management effectiveness.
- Scores range from 1 to 5 stars.
- Uses Sustainalytics company-level ESG data.
- Reflects portfolio ESG risks and controversies.
What is Morningstar Sustainability Rating?
The Morningstar Sustainability Rating measures how well the companies in a fund’s portfolio manage environmental, social, and governance (ESG) risks compared to similar funds. It helps investors identify funds with lower exposure to unmanaged ESG risks, supporting responsible investing decisions.
This rating is expressed on a scale from 1 to 5 stars and is based on company-level ESG data sourced from Sustainalytics, a Morningstar subsidiary specializing in ESG research.
Key Characteristics
Key features of the Morningstar Sustainability Rating include:
- Star-based scale: Ratings range from 1 (lowest) to 5 stars (highest) to indicate ESG risk management quality.
- Fund eligibility: Applied only to funds with at least 50% of assets in companies rated by Sustainalytics.
- ESG pillars: Evaluates Environmental, Social, and Governance factors separately and in aggregate.
- Portfolio-level focus: Aggregates company ESG scores into a portfolio sustainability score using asset-weighted averages.
- Controversy adjustments: Deducts points for holdings involved in significant ESG controversies.
How It Works
The rating process uses a rigorous five-step methodology that starts by identifying portfolio holdings exposed to ESG risks and calculating their sustainability scores over a trailing 12-month period. These scores incorporate normalized company-level ESG data to ensure comparability across industries.
The portfolio’s corporate and sovereign sustainability ratings are then determined relative to the Morningstar Global Category, combining these ratings proportionally to produce the final star rating. Historical weighting emphasizes recent portfolio changes, giving you a more current perspective on ESG risk management.
Examples and Use Cases
Investors use the Morningstar Sustainability Rating to align portfolios with ESG goals and screen for funds with strong sustainability practices. Examples include:
- Airlines: Delta and American Airlines face distinct ESG challenges, and their ratings can impact funds holding these stocks.
- ESG-focused funds: Many exchange-traded funds listed in best ETFs utilize this rating to showcase their sustainability credentials.
- Low-cost indexing: Some low-cost index funds incorporate ESG ratings to offer broad market exposure with an ESG tilt.
Important Considerations
While the Morningstar Sustainability Rating offers valuable insight into ESG risk management, it relies heavily on Sustainalytics’ data and the accuracy of underlying company disclosures. Ratings may not capture all nuanced risks or opportunities, so it’s advisable to use them alongside other research tools.
Additionally, understanding how ESG factors integrate with broader macroeconomics and fundamental analysis can improve your investment decisions. For investors exploring ESG, the rating system provides a standardized starting point but should be complemented by ongoing monitoring and evaluation.
Final Words
The Morningstar Sustainability Rating offers a clear metric to gauge how well a fund manages ESG risks compared to peers. To apply this insight, review the ratings of funds you’re considering and weigh them alongside your overall investment goals.
Frequently Asked Questions
The Morningstar Sustainability Rating measures how well companies in a fund manage environmental, social, and governance (ESG) risks compared to similar funds. It helps investors understand the ESG risk exposure of their investments.
The rating is calculated through a five-step process that includes identifying ESG risks in portfolio holdings, calculating corporate and sovereign sustainability scores, determining historical scores, assigning category ratings, and combining these into a final rating from 1 to 5 stars.
Funds with at least 50% of their assets invested in companies that have Sustainalytics ESG ratings are eligible. Sustainalytics is Morningstar's subsidiary specializing in ESG data.
The rating uses a 1 to 5 star scale, with 5 stars indicating the best management of ESG risks and 1 star indicating poorer management relative to other funds in the same category.
Morningstar uses Sustainalytics’ company-level ESG risk ratings to calculate a portfolio’s sustainability score by asset-weighting the normalized ESG scores of all holdings and factoring in any controversies.
Sustainalytics assigns ESG risk ratings from 0 to 100, with categories ranging from negligible risk (0-9.99) to severe risk (40+). These scores help determine the overall ESG risk exposure of the portfolio.
Historical scores over the trailing 12 months are used to add consistency and reflect recent portfolio management decisions, with more weight given to the most current scores.
Yes, the rating combines corporate and sovereign sustainability ratings based on their relative contributions within the portfolio to provide a comprehensive ESG risk assessment.
