At long last, the investing research firm Morningstar has formally integrated environmental, social and corporate governance (ESG) factors into its stock, fund, and asset manager analyses using a framework that will capture ESG risks across over 1,500 stocks.
Morningstar had already included ESG risks within its analyses, Adam Fleck, the company’s regional director of equity research, told Stockhead. It became time, however, for the firm to capture those factors in a more formal and consistent fashion, he said. “We were afraid [including ESG factors] outside our core process would miss an opportunity to integrate it into [the] traditional realm of long-term valuation based investing,” Fleck explained. “We’re not going to be launching another separate rating within Morningstar equity research. It’s going to be integrated into principally the moat rating, their competitive advantage, and our uncertainty rating.”
Morningstar’s development is representative of a worldwide increase in fervency toward sustainability, even during the coronavirus pandemic when nations and businesses have new contingencies to grapple with.
The firm will use data from ESG ratings and research company Sustainalytics, acquired by Morningstar in June, to create informed analyses built around 20 material ESG issues, including the environmental and social impact of products and services, occupational health and safety, human rights, and resource use in supply chains. Morningstar will then use this data to analyze how ESG risks could materialize and impact a company’s valuation. The result is a five-star stock rating system with ESG factors fully integrated. Asset managers and strategies are rated on a four-point scale.
Integrating ESG metrics does not indicate that Morningstar has strayed from its focus on financial returns, Fleck emphasized to Stockhead. Morningstar simply recognizes that ESG analysis is now essential information for long-term investors, he said — and that’s because a company’s ESG-related commitments and actions are intrinsically connected to its cash flow and success, a pattern that investors are recognizing now more than ever.
While 2020 was a troubling year for the global economy, as the coronavirus pandemic has slowed overall activity, both ESG innovation and investment have still increased. The exacerbation of health and equity crises have been coupled with racial injustices and protests and unprecedented wildfires across the western United States. The events of this year have carried reverberations across the global consciousness — and they haven’t fallen under the radar of investors.
“Over $19 billion has flowed into ESG [exchange-traded funds] this year, bringing the total to over $40 billion,” Luke Oliver, head of index investing for the Americas at DWS Group, told CNBC’s ETF Edge. “Just to put that in some context, there was less than $8 billion in inflow last year, and prior to that the flows were very scant.”
“There’s a capitalist endeavor behind E, S and G, because they give you companies that are better-prepared” for the future, Oliver told CNBC.
In an attempt to make wiser decisions, large investment groups have been putting companies on notice for ESG issues, including workplace equity and climate action. Investors recognize that they are specially positioned to compel companies to change course.
One case of success is with deforestation. The sustainability advocacy nonprofit Ceres reports that 51 shareholder proposals were filed by U.S. investors between 2011 and 2017, asking corporations to adjust their relationship to unsustainable palm oil and other deforestation-related commodities. According to Ceres, 23 companies responded with measurable actions and significant economic impact. The not-for-profit environmental reporting charity CDP estimates up to $906 billion in annual corporate turnover could be at risk due to deforestation.
Where Morningstar fits into this picture of positive investor influence is in its purpose to bring investment research to the average shareholder. Its updated rating system puts power into the hands of the ordinary individual to make wise investment decisions for their own portfolio and for the resiliency of the world. The company operates in 27 countries, and millions of people use its resources.
These days, a corporate environmental, social or governance commitment is a dime a dozen. Sifting through empty promises and measurable impacts can be impossible without insider information. Morningstar’s ESG-integrated rating system brings transparency to the process and empowers the average investor in what feels so often like an otherwise chaotic time.
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