CFA, director of investment research for Morningstar Canada.
What are we looking for?
Canadian mutual funds and exchange-traded funds (ETFs) that have managed environmental, social and governance (ESG) risks well.
The screen
As most Canadians enjoy the last weeks of summer, we look with condolences at the damage caused by the Jasper wildfires, which have resulted in eye-watering damage to the region, including multimillion-dollar losses across real estate properties. These types of events act as reminders to investors that some types of risks are not immediately evident in traditional financial reporting.
Along this vein, I remind readers about the idea of measuring environmental, social and governance risks, and actively considering them in investment decisions. Today’s modern ESG risk scores (including those from Morningstar Sustainalytics) don’t measure the “goodness” or “green-ness” of a company. Rather, they measure the financially material risks that stem from ESG factors – and assess a company’s ability to manage these risks. For example, a company that has good corporate policies around fair pay for employees is less likely to face the costs and disruptions of a union strike. Similarly, a company with physical assets in politically unstable regions, or regions susceptible to natural disasters, without appropriate contingencies might be more likely to be exposed to unexpected events that cause financial losses.
With the above in mind, today I use Morningstar Direct to screen for top-performing mutual funds and ETFs that, based on Morningstar’s assessment, exhibit lower degrees of ESG risk. To find these investments, I screened for Canadian-domiciled funds and ETFs (today exceeding 4,000 unique investment strategies) that have received:
- Morningstar rating for funds of five stars. This rating is an objective look back at the risk-adjusted after-fee performance of the fund, relative to its category peers. The rating considers 10 years of performance history, if available, and puts greater emphasis on recent performance.
- Morningstar sustainability rating of five globes. The rating is a measure of how well the companies held by a fund are managing their ESG risks and opportunities when compared with similar funds. We use company-level ESG data from Sustainalytics, a leading provider of ESG ratings and research, to calculate the rating.
- Morningstar medalist rating of gold, silver or bronze. Morningstar’s medalist rating is our forward-looking view of a fund’s ability to outperform peers on an after-fee basis, rooted in our analysis of people (quality of the management team), parent (stewardship of the fund company) and process (robustness of investment process).
Only the oldest share class of each fund was considered in this analysis.
What we found
The mutual funds and ETFs that qualified in the screen are listed in the table accompanying this article, alongside their categories, ratings, management expense ratios (MERs), trailing performance and inception dates.
Investors should first look at the category to which each fund belongs, given that our ratings are applied relative to category peers.
Also, of the qualifying funds, only three of them have advertised themselves as funds that have a focus on sustainable investing (as evidenced by the names and accompanying prospectus disclosures). In other words, the minority of funds on this list have an objective to achieve some sort of ESG-related outcome. The others, like most funds, simply have a focus on maximizing investors’ risk-adjusted returns, but their portfolios exhibit lower degrees of ESG risk than their peers – a worthwhile consideration for any investor regardless of their personal views on sustainable investing.
This article does not constitute financial advice. It is always recommended to conduct one’s own independent research before buying or selling any of the funds or ETFs mentioned in this article.