Morgan Stanley
  • Wealth Management
  • May 7, 2021

How to Choose a Sustainable Mutual Fund

Identifying sustainable investments that are truly focused on environmental and social goals can be harder than you might expect. Here’s how to go about it.

Susan K. McDowell Wealth Management Investing with Impact Investment Officer

Each year, I meet more investors who are interested in putting their financial resources to work to help achieve environmental and social goals. The asset-management industry has been responding with a plethora of new offerings.

More than 3,000 asset managers worldwide, with a total of $103 trillion in assets, have now signed the United Nations’ Principles for Responsible Investing.1 Over 69% of the 300 traditional asset managers we cover at Morgan Stanley Wealth Management integrates ESG into the investment process for one or more of their offerings.

More may be better, but it can make it more challenging for investors to differentiate amongst the choices, particularly in regards to how each manager approaches environmental, social and governance (ESG) goals. In particular, investors naturally want to avoid choosing managers who may be claiming an environmental or social focus without providing many significant benefits to that cause. 

Serious About Sustainability

Manager selection is critical. Morgan Stanley has a multistep process to help clients identify the sustainable funds that are driving lasting positive impact, while generating returns that track the asset classes they invest in. These reviews are in addition to the comprehensive quantitative and qualitative analysis and business and operational review we conduct for all asset managers we cover. 

Managers considered for Morgan Stanley’s Investing with Impact Platform are evaluated across multiple dimensions. Some of the documents we review, such as a manager’s proxy voting history and prospectus or offering documents, are publicly available for interested investors. Here’s what we look for:

  • A documented sustainable investment process. Is there specific language in a prospectus or offering document that describes the ESG factors emphasized and how the impact criteria are incorporated into the investment process? We expect the process to be repeatable and defensible, with clearly drawn lines for when they will or won’t invest, based on sustainability factors. 
  • An experienced sustainable investing team. We find that the most successful asset managers hire leaders in sustainable investing to develop an investing framework and team that includes portfolio managers and analysts who perform ESG research, alongside fundamental financial analysis.
  • A well-defined and repeatable method for evaluating data. ESG data can vary by sector, region and data provider. We look at how fund companies use data from third-party providers, as well as how they deal with gaps in data and incorporate their own research.
  • Demonstrated shareholder engagement around sustainable initiatives. This is often critical in ESG investing. Managers can file shareholder resolutions, vote proxies and speak directly to company management to amplify sustainable goals.
  • Strong impact performance. We compare performance to both sustainable and traditional peers and benchmarks. Our highest conviction managers are added to our Focus List, including 22% of the eligible investment products on our Investing with Impact Platform.
  • Sustainable outcomes measurement and impact reporting. Managers are increasingly developing reports that investors can use to assess how a fund’s sustainable investing methodology lines up. These reports can help investors assess the alignment of a fund’s investments with its stated impact objectives and measure the impact. Your Financial Advisor can share what is available, or you can call the company and ask.

Not all managers take the same approach. When it comes to the investment process, managers can avoid industries and countries that have negative records or they can seek out companies with strong track records. They can also look for companies that aim to solve or impact a specific problem. While there is no right way, investors should determine what is most important to them before choosing a manager.

More Growth Ahead for Sustainable Mutual Funds

We expect the number of sustainable investment offerings to continue to grow in the coming years. A recent survey from the Morgan Stanley Institute for Sustainable Investing and Morgan Stanley Investment Management found that 95% of the 110 global asset owners surveyed, are pursuing or actively considering pursuing sustainable investing in all of part of their portfolios. 

Our manager evaluations team can help clients, working with their Financial Advisors, identify the portfolio managers who are likely to achieve both their investing and sustainability goals. Investors with the time and determination to dig deep into fund documents can also find answers to some of the same questions we ask every day. 

This article was based on a May 2021 special report, “Sustainable Investing: GIMA’s (Global Investment Manager Analysis) Due Diligence Perspective.” Emily Thomas, Wealth Management’s Investing with Impact Lead Analyst, and Meredith Loughlin, Investing with Impact Analyst were additional authors.

1 Principles for Responsible Investment - https://www.unpri.org/signatories/signatory-resources

Risk Considerations

Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies.  Technology stocks may be especially volatile.

The returns on a portfolio consisting primarily of environmental, social, and governance-aware investments (ESG) may be lower or higher than a portfolio that is more diversified or where decisions are based solely on investment considerations. Because ESG criteria exclude some investments, investors may not be able to take advantage of the same opportunities or market trends as investors that do not use such criteria. The companies identified and investment examples are for illustrative purposes only and should not be deemed a recommendation to purchase, hold or sell any securities or investment products. They are intended to demonstrate the approaches taken by managers who focus on ESG criteria in their investment strategy. There can be no guarantee that a client's account will be managed as described herein.

Equity securities may fluctuate in response to news on companies, industries, market conditions and general economic environment.

Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets.

Rebalancing does not protect against a loss in declining financial markets.  There may be a potential tax implication with a rebalancing strategy.  Investors should consult with their tax advisor before implementing such a strategy.

International investing entails greater risk, as well as greater potential rewards compared to U.S. investing. These risks include political and economic uncertainties of foreign countries as well as the risk of currency fluctuations. These risks are magnified in countries with emerging markets, since these countries may have relatively unstable governments and less established markets and economies.

Investing in foreign emerging markets entails greater risks than those normally associated with domestic markets, such as political, currency, economic and market risks.

Certain securities referred to in this material may not have been registered under the U.S. Securities Act of 1933, as amended, and, if not, may not be offered or sold absent an exemption therefrom.  Recipients are required to comply with any legal or contractual restrictions on their purchase, holding, and sale, exercise of rights or performance of obligations under any securities/instruments transaction.

Disclosures

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