We have made some changes to the Morningstar Sustainability Rating for funds, which will increase the number of funds receiving ratings. It is important to note that we will now provide global ratings, which measure ESG risk against category peers, for most fixed income funds and allocation funds.
To do this, we will now integrate the established products of Sustainalytics Country risk rating scores for sovereign securities. Previously, our rating included the ESG risk of corporate issuers only by using Sustainalytics ESG risk assessments. Morningstar’s sustainability rating methodology is unique in that it takes a modular approach, independently rating and ranking the corporate and sovereign parts of the portfolio. This allows for a more nuanced view of the portfolio’s risk exposures, which allows for a better comparison between similar strategies. Indeed, the corporate part of the portfolio is often the area where a fund manager has more opportunities to manage the fund’s ESG risk exposure, while it is common for peer funds to have very similar sovereign exposure.
How it works
This is a simplified flowchart of the process used to determine the rating.
First, we look at the types of holdings in the fund’s portfolio and whether the securities are eligible for ratings. We require that most securities in the portfolio (at least 67%) be rated.
Then the two wallet pockets are noted. To calculate the corporate portfolio sustainability score, we take each security’s ESG risk rating score, which measures the degree of risk to a company’s economic value (enterprise value) due to factors ESG. It applies to shares, bonds issued by legal persons, certain securitized claims and supranational entities. We average the scores of the securities in the portfolio on an asset-weighted basis to obtain the portfolio’s corporate sustainability score.
To calculate the sovereign sustainability score, we use Sustainalytics Country Risk Ratings, which assesses the prosperity of countries taking into account their access and management of natural, human and institutional resources, which corresponds to the assessment of environmental factors, social and governance factors in the ESG ratings of companies. Sovereign rating applies to issues of fixed income securities by government entities and to a selection of securitized debt.
The next step is to calculate the historical portfolio sustainability scores for the corporate and sovereign sleeves. Historical scores are a weighted average of the past 12 months of Morningstar Portfolio Corporate and Sovereign Sustainability scores, respectively. Historical scores are not equally weighted; rather, the more recent portfolios are weighted more heavily than the more distant portfolios.
Historical corporate and sovereign ratings are ranked independently from all other rated funds within a peer group of the Morningstar Global Category to achieve a rating for the corporate and sovereign portions of the portfolio.
Finally, we combine the portfolio’s corporate sustainability rating and the portfolio’s sovereign sustainability rating. We weight corporate and sovereign scores in proportion to the fund’s actual portfolio to achieve the overall Morningstar sustainability rating.
Rating in action
Let’s take a look at an example. IShares ESG US Aggregate Bond ETF (EAGG) is an exchange-traded fund that offers investors exposure to the quality bond market with an ESG orientation. This fund, which receives a Morningstar Silver Analyst Rating, tracks the Bloomberg Barclays MSCI US Aggregate ESG Focus Index, a market value-weighted index composed of US Treasury bonds and debt securities denominated in securitized US dollars, corporate and government dollars. – related obligations. It targets the same broad sector weightings as the Bloomberg US Aggregate Bond Index.
The new methodology allows us to assign this fund a Morningstar sustainability rating for the first time:
– source: Morningstar.com
IShares ESG US Aggregate Bond ETF obtains an overall rating of 4 globes. This means that this fund is exposed to less ESG risk than most of its peers in the global US fixed income category.
Here’s how it breaks down: The corporate sleeve of the portfolio receives average ratings (historical and current) for ESG risk exposure. The portfolio’s current and historical sovereign sustainability scores are lower but contribute slightly less to the overall portfolio rating (53% for the Corporate Sustainability contribution versus 47% for the Sovereign Sustainability contribution).