How do you rate the sustainability of a company or mutual fund? Do you focus on whether it avoids negative consequences or on the positive impacts it has? Do you look at internal operations and corporate governance or external business activity? These questions require consideration when developing a rating method for sustainable and ESG (environmental, social, and governance) funds, which is exactly what a number of firms have done.
Ratings companies, including Morningstar, MSCI, and others, have developed systems to evaluate and rate companies and mutual funds on ESG factors. As demand for impact and ESG investments grows, being able to compare and assess funds based on these criteria will be of enormous value. We are excited that the industry is beginning to recognize the need and provide solutions that will help investors understand and evaluate the sustainability profile of different investment offerings.
However, we would caution investors that not all sustainability ratings are created equal; methodologies vary widely across different firms, and a fund that scores highly in one rating system may not rank so well in another. For example, Morningstar’s ratings focus on internal governance practices, whereas As You Sow and 3D focus more on outward environmental and social impacts. A single rating, therefore, is not necessarily an overall indication of a fund’s sustainability, but a view from one direction.
Can sustainability ratings still be helpful? Of course; we suggest first considering what, as an investor, you are seeking in a fund as it relates to ESG or impact factors, and then using ratings systems to help evaluate those criteria. We expect this industry to continue to grow and will likely see more consistent ratings methodologies as firms learn from experience and adapt to meet investors’ needs.