Appetite for sustainable investing has never been higher.
Whether it’s a heightened societal awareness stemming from the Covid-19 pandemic, adverse weather events that populate news bulletins, or the latest episode of Blue Planet, people have become more conscious of sustainability issues and want to use their purchasing power to back businesses that care about a greener future.
But how do investors actually align their unique sustainability preferences with material financial decisions? Well, it’s all down to approach.
The sustainable investing universe can be a confusing, jargon-laden space for many. There’s no one-size-fits-all way of doing things. Rather, incorporating sustainable preferences encompasses a range of approaches that have continued to evolve over many years.
To make things clearer, we’ve developed the Morningstar Sustainable Investing Framework – a straightforward way to understand investor motivations for seeking sustainable investments and the range of activities associated with each approach.
The Exclusionary Way
Applying exclusions is typically considered as one of most straightforward approaches that investors can adopt when choosing to invest sustainably.
As shown above, it sits on the avoiding negative outcomes side of the continuum and refers to the deliberate avoidance of investments in companies, industries, or sectors that may negatively affect the planet or society – like those tied to fossil fuels or tobacco, for example.
Exclusions have evolved over the years too, as more investors become aware of how negative corporate behaviour around ESG issues can hurt shareholder value as well as having a detrimental effect on the world around us.
During what some might call the “ethical” investing period from the 1700s to the 1960s, applying exclusions typically meant excluding “sin” sectors such as alcohol, tobacco, gambling, adult entertainment, and faith-based exclusions.
An era of “socially responsible” investing began in the 1960s and lasted until the early 2000s, focusing on investment aspects of specific social issues of the day such as controversial weapons, nuclear energy and arms, civil rights, and business ethics.
This approach was a response to various conflicts, industrial disasters, or oppressive regimes around the world at the time.
Only in the early 2000s did the move towards “sustainable” and “ESG” exclusions become prevalent. Even then, it wasn’t really until around 2018 that the fund management world really started to take notice. Fund houses that boast of a five-year track record on ESG are among the more experienced of their peers. But five years isn’t a long time in the long run.
Either way, the phenomenon owes a lot to the financial services’ broad attempts to align itself with the United Nations’ Sustainable Development Goals, a globally recognised framework for evaluating environmental and social impact.
Common exclusions under this approach include thermal coal and other fossil fuels, as well as violators of the UN Global Compact which promotes human rights, environmental protection, and anti-corruption measures.
In practice, applying any of the above exclusions to today’s investable universe can be done on an absolute or relative basis. Investors may look at absolute emissions from a climate perspective, or may choose to consider percentage revenue thresholds relative to certain industries instead. In any case, the big question to consider is this: how can investors be sure that their sustainable intentions match the reality of their investments?
Intention vs Reality: Where the Data Comes In
Adopting the exclusionary approach requires access to good quality ESG data. That’s because, in the day and age where ESG sells, it’s not hard to see why managers might be tempted to overpromise and under-deliver the “sustainable” products they’re providing – the familiar greenwashing problem.
When it comes to applying exclusions, therefore, an investor who chooses a fund based on the stated exclusions that it employs (e.g. fossil fuels and tobacco), needs an accurate way of verifying its managers’ claims about its title, purpose and goals.
Leveraging ESG Data to Employ Exclusions
Morningstar has a comprehensive offering to help professional investors and managers successfully consolidate ESG data into the investment process to help meet investor preferences for sustainable investing, including applying exclusionary policies.
Investments are screened using several key data sets, as well as Morningstar’s propriety sustainability ratings, to ensure unique ESG preferences are correctly reflected in end investments.
To find out more about how exclusions can be used to invest sustainably, and the full suite of ESG data and research available from Morningstar, you can download our new Guide to Applying Exclusions here.
