By Janet Brown
What makes a fund sustainable?
Many people think that sustainable means environmentally friendly, but sustainable investing actually covers three broad categories: environmental, social and governance (ESG).
Environmental issues are typically the most widely understood, but social and governance policies are just as important. A socially responsible company seeks to treat its workers fairly and create products that help people and are safe to use. A well-governed company balances the needs of its executives and its shareholders. It’s overseen by an independent board of directors and operates in an ethical way without relying on corruption and bribery to get ahead.
ESG policies are often material to a business’ success. There are many examples of companies cutting costs by using renewable energy or conversely getting slapped with fines and lawsuits due to poor environmental results. Studies have repeatedly found that companies with good ESG policies also have performed well.
For many years, the answer was to look for funds that had ‘sustainable’ or ‘socially responsible’ in their names. These funds usually consider a company’s ESG practices as part of their investment selection process. But this can limit your investment choices since only a small fraction of funds self-identify as ‘sustainable’ funds. According to Morningstar, these funds represent just 2 percent of the fund universe.
Today, you can substantially expand your choices by using new ESG -- environmental, social and governance – ratings for mutual funds. A 2016 MSCI study found thousands of funds have “significant exposure to sustainable impact themes," but just 14 percent of these funds are self-professed ESG or sustainable funds. For instance, MSCI found that more than 1,000 U.S. stock funds are “virtually ‘fossil fuel free,' even though very few of these funds – if any – were marketed as such."
MSCI has calculated individual company ESG ratings for decades, and now they’re using this data to provide metrics on funds and ETFs. Morningstar is better known for their performance-ratings of funds, and their new sustainability scores are based on ESG data from Sustainalytics. (Morningstar’s globes ratings, as shown on Morningstar.com, indicate how a fund’s sustainability score compares to those of the other funds in its Morningstar category.)
There are limitations to these ratings, however. For instance, they don’t take a fund’s strategy into account. Many funds use their power as shareholders to engage with a firm’s management and file shareholder resolutions. This approach has had notable successes and has really helped companies move forward.
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Janet Brown is the President and CEO of FundX Investment Group. She manages fund portfolios for high-net worth clients and foundations. She also manages a sustainable mutual fund. Janet is a board member of several non-profits and foundations and a longtime advocate for sustainable, responsible impact investing (SRI).