What You Need To Know About Fund Sustainability Ratings



Given the choice between two funds that have similar returns, many people prefer to invest in the one that prioritizes investing in companies that focus on clean energy, good governance or are committed to data security or equality.

Sustainable ratings for mutual funds can help you find these kinds of funds, but because most of these ratings are fairly new, many investors aren’t sure how to use them effectively.

Sustainability fund ratings were a major topic of conversation in my recent webinar with FundX Portfolio Manager Avani Rau and Morningstar’s Director of ESG Solutions Tanya Svidler. Rau and Svidler offered practical insights on what ratings really measure, how you can access them, and, most importantly, how to put them to work in your portfolio.

Here are four things you need to know about fund sustainability ratings:

1. What’s the cost? Some ratings are free; others are not

Morningstar globe ratings indicate how an investment fares in its industry group. They’re  available for free at Morningstar.com and even at Yahoo Finance. “We really aim to make those as widely available as possible,” Morningstar’s Tanya Svidler said.

More detailed sustainability ratings, like Morningstar Portfolio Sustainability Scores, allow you to evaluate each fund’s holdings on its own merit, however, these scores come at an extra cost. This data is available through Morningstar software platforms, which are built for professional investment advisors, and they can be cost prohibitive for individuals or smaller advisors.

2. What do ratings measure? Ratings are based on potential risks, not returns

Morningstar’s ratings assess a fund’s underlying holdings using environmental, social and governance (ESG) characteristics using research and analytics from Sustainalytics.

The ratings “are very much risk-based,” Svidler explained. “The idea is to really identify long-term risks and to identify those players that are doing a better job versus the rest of the industry with regard to management of those long-term risks.”

It’s important to remember that “sustainability ratings are portfolio based, not performance based,” FundX’s Avani Rau explained. A fund could have a great sustainability rating even though it hasn’t performed well.

3. How do I use these ratings to find funds? Some ratings are category specific

Morningstar’s globe ratings are specific to a fund’s Morningstar category. “Funds are compared against their respective Morningstar retail category peers, so that U.S. large-cap value funds are compared against other U.S. large-cap value funds etc,” Svidler noted.

This is great if you know that you want to invest in a U.S. large-cap value fund, but if you’re trying to choose between a U.S. large-cap fund and a foreign fund, the globe ratings aren’t going to give you the apples-to-apples comparison you need.

Morningstar Portfolio Sustainability Scores, on the other hand, aren’t based on fund’s category, so they can be used to make broader investment decisions. But these portfolio scores aren’t free or readily available on Morningstar’s web site.

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