Improved analytics are helping investors unlock the environmental and social impacts of a wide range of companies and funds
This article was produced in partnership with Morningstar Inc.
Morningstar Inc. has been the go-to source of independent research for investors since 1984, and a key reason for the firm’s success has been its ability to adapt to change.
So when a rise in environmental, social and governance (ESG) risks began to influence investment decisions, Morningstar was ready. In 2020, the company bought Sustainalytics and its suite of research and data analytics solutions, giving investors a powerful new tool to evaluate ESG performance.
Sustainalytics has deep roots in Canada going back to its founding in 1992, so it’s no surprise that Canadian investors are becoming increasingly aware of the importance of ESG in their portfolios.
“We first partnered with Sustainalytics in 2016 when Morningstar was one of the first companies to provide an ESG rating for funds in Canada,” says Ian Tam, Director of Investment Research, Canada, at Morningstar. “We were early, and then we ended up purchasing Sustainalytics so obviously we were very invested in how ESG was evolving.”
Tam spoke with Wealth Professional recently to discuss the reach of these analytical tools and their impact on ESG investing in Canada.
Canada and ESG
The Canadian economy is heavily dependent on natural resources like oil. This poses a challenge for investors who need to balance ESG considerations with an investment landscape that is disproportionately weighted to industries like mining, forestry and oil.
“We're in a unique situation because a large percentage of our GDP comes from the energy sector,” Tam says. “And of course that sways any decision to invest in ESG.”
However, Tam points out that a common misunderstanding among investors is that an ESG investment is a simple matter of good or bad. It’smore of a gradient than this, he says, and Canadian investors have many options to choose from.
“Investing sustainably is not a binary decision,” he explains. “There's a wide spectrum of approaches the investor can use to meet their objectives. It’s a message that’s missing in the market today.
“We can see that this message isn’t always getting through, because although sustainable investment is growing quickly in Canada, it still represents a very small share of retail mutual fund assets at around 2%.”
Despite the perception that Canada is a leader on ESG initiatives, Tam suggests the country is lagging not only Europe, but the United States as well.
“Europe is miles ahead in terms of what needs to be reported,” he says. And I would say the United States and Canada are behind.”
Education
Asked to explain why Canada is failing to keep up with Europe with regards to ESG investments, he cites the lack of awareness.
“The biggest headwind in Canada is investor education. The next generation of advisors needs to catch up on what it means to invest sustainably. Fortunately, we now have a concrete framework in place that is helping to identify the funds to approach.”
Tam is referring to a framework developed by The Canadian Investment Funds Standards Committee, which he chaired last year. The CIFSC helps define categories of mutual funds in Canada, and it recently introduced six clear approaches to sustainable investing.
“Having this framework really crystallizes which funds have stated that they use a defined sustainable approach. It makes things much less nebulous.”
Data
The framework goes a long way to clarifying the relative sustainability of different funds, but for a deeper understanding of what’s under the hood investors need data. And that’s where Sustainalytics comes in.
“Sustainalytics provides a large library of metrics and analysis to assess the risk from carbon emissions and other concerns. We're able to aggregate those stats up to the portfolio level, and then make a comparison between fund A and fund B.”
Acquiring the information to power these data solutions isn’t easy, as Tam explains.
“Measuring impact is difficult. As such, very few funds state in their prospectus documents that they will report on their impact.”
Despite the challenges, Tam says the trend is toward more openness. Along with increased awareness among investors and greater clarity from funds, Tam says ESG investments are also seeing heightened interest among Canadian regulators.
“The biggest tailwind in the last couple years is the regulatory environment,” Tam says. “We finally have guidance that essentially requires fund manufacturers to disclose what they mean when they have an ESG-related fund. That guidance has been important.”
Looking ahead, Tam says although Canada is still behind Europe and the United States in terms of ESG investments, that is starting to change.
“We've seen an explosion of ESG-related investment funds coming to the market. Climate change is top of mind for many people, and wealth is shifting to Gen X and Millennials who are more receptive to sustainable investments.”
