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Morningstar ready to roll out more sustainable ratings

It has been a hectic first year for the Morningstar Sustainable Investing Initiative. Head of Sustainability at investment analysis company Morningstar, Steven Smit, looks at the ups and down from the past year but also gives a sneak peek at what Morningstar is getting ready to roll out in 2017 as an expansion of the current Sustainable Investing Initiative.

Steven Smit, head of sustainability at Morningstar. Photo: Morningstar

Usually having a baby around is a lot of work, and quite often it is an ungrateful job trying to teach the little one how to integrate with with the rest of the world without too many fallouts.

But for Morningstar it has been a different story. At least for the company's most recent "baby", the sustainable rating system.

Perhaps it's because the preparations took almost two years before the sustainability rating system was actually launched. At least, Morningstar's now 1-year old Sustainable Investing Initiative was pretty much able to walk and talk from the day it was born.

There has been some crying and falling over, but not a lot, according to Morningstar's Steven Smit. And most users have received the newcomer in a positive way, though there has also been critique along the way, Morningstar tells FWAM.

"The largest points of critique we have experienced in the past year have mainly focused on three things: Some think the ratings are biased, some criticize the globe system (the rating gives out globes from one to five. Five being the best) creating winners and losers in each section, and some are unhappy with us rating both conventional as well as intentional funds," Steven Smit explains to FWAM. He's the Amsterdam-based Head of Sustainability at Morningstar.

Morningstar started out rating around 21.000 funds but only a year later the number is up to 35.000 funds.

"Because we hand out as many bad ratings as good, somewhere along the lines someone is bound to be unhappy with what we do," Steven Smit explains.

Steven Smit points to the fact that the actual intentional funds within sustainability only make up for approximately three percent of the market. But rating the conventional funds also makes a lot of sense if you ask Steven Smit:

"Let's compare it to cars. Some manufacturers may pride and market themselves on making the safest cars in the world. Other car producers are more about appearance of the car or the driving capabilities but they all have a safety aspect. So why would you only rate the car that promotes itself on safety, when they all have a safety aspect? In our industry we know there are funds out there that without making a big fuss about it are investing in quite a sustainable way, so why wouldn't you rate them too?” Steven Smit asks.

Changes in methodology will come

Morningstar has also received complaints about their definition of sustainability being different from the definition the funds have for sustainability. To this conflict of interest Steven Smit underlines that Morningstar offers a rating tool, not a final answer to how to be sustainable:

"We are giving investors a starting point. The methodology is strong and true – the rating sends investors in the right direction. But if they are navigating towards a very specific and personal place in the world only using our sustainability rating tool they might come close to that place, but not land in that place with a 100 percent accuracy. To get to exactly that place they have to use additional information from us or other sources," Steven Smit says.

Morningstar takes the input and the complaints seriously but they haven't actually changed anything in the methodology based on complaints in the past year. But there will be changing in the next months and years to come Smit says: "We haven't done anything tangible in changing the methodology yet. We are listening to the critique – some points are valid, but we also think that the way the rating is now it's good. Can it get better over the years? Does the industry have some fair point that we are looking at? Absolutely. We are looking at ideas to make it better."

Smart Beta and more transparency coming up

The Sustainable Investment Initiative has its limits the way things are set up today. For example you will not find a rating of say government bonds or funds of funds combined with sustainability – yet. The plan is to cover governmental bonds and funds of funds in the near future. The funds of funds are technically difficult to do. But they are working on it at Morningstar's offices. But some things also depend on the supply of data that Morningstar can get from their supplier of sustainable data, Sustainalytics.

Amongst possible launches for 2017 Steven Smit is planning on Smart beta indexes: "I am not making any hard promises but we hope to launch one or several Smart Beta Indexes in 2017. We could combine high sustainability with high dividend, or with low valuation or other interesting factors. We have our own equity research team in house, so we can combine their research concepts for companies with sustainability and thereby make smart beta indexes," Steven Smit explains. However, what he is willing to promise for 2017 is an increase in transparency for fund managers. Within the next couple of months Morningstar is hoping to make it even more visible to fund managers why they get the rating they get.

"One can already see the calculations online in the methodology document. But we want to launch data feeds where asset managers can see all their individual holdings in their companies and their E, S and G scores and the controversy scores that are going into this formula for the sustainability ratings so they can see exactly why they are scored the way they are," Steven Smit explains.

The silent revolution

Steven Smit emphasizes that Morningstar will keep investing in the ESG research area: "The market is expanding fast because this is where the demands of the end clients lie. If investors can chose more sustainably by using our ratings then in the end we have contributed to making the world a better place. And that thought appeals to people working for Morningstar and to our clients."

Is this a political statement for Morningstar?

"No, we as a company do not wish to be political. But if you ask me personally I can say that my experience is that the world is paying more attention to ESG-issues independent of which administration is in power. I do not think that one administration or one person can reverse that silent revolution that is happening these years," Steven Smit explains.

He points to the actions taken by the financial industry even after the latest US election. Actions that support the theory of the world becoming more aware of urgent problems related to ESG.

"There is no hesitation in pursuing ESG (in the financial industry). When you look at the latest GSIA report (Global Sustainable Investment Alliance) you’ll see that the growth in the US and Canada has been even more robust than in Europe. After the US election you have seen somebody like State Street saying it would vote actively on gender equality, Blackrock saying they will vote more actively on climate change issues, JP Morgan extending their ESG department and launching a range of new sustainable funds. The financial industry is just going where the consumer is taking us and they are taking us to a higher level of sustainable awareness," Steven Smit concludes.

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