What Is the Morningstar Sustainability Rating?

What Is the Morningstar Sustainability Rating?

Let me explain to you what the Morningstar Sustainability Rating is—it's a framework I use to compare thousands of mutual funds and exchange-traded funds (ETFs) based on environmental, social, and governance (ESG) standards.

I introduced this rating in 2016 and have updated it since then. It employs five 'globes' to show where a fund stands on ESG within its industry group, ranging from one globe at the bottom to three for average, up to five globes for the highest. These ratings come out monthly.

Key Takeaways

You should know that the Morningstar Sustainability Rating helps you evaluate funds based on their environmental, social, and governance (ESG) characteristics. The ratings use a five-globe system, where one globe is the lowest score and five is the highest.

These sustainability ratings depend on how much a fund’s holdings are at risk due to ESG factors. Each company in the portfolio gets graded on a scale of 0 to 100 relative to its industry peers. For a portfolio to get a sustainability score, at least 67% of its assets under management must have a company ESG score.

Understanding the Morningstar Sustainability Rating

I developed this rating system partly because sustainability has become dramatically more important in investment decisions.

Remember, companies are rated relative to their global peers, so two firms with the same score but in different peer groups might not have equivalent ESG performance.

The ratings draw from research by my Sustainalytics firm and its ESG risk ratings, which measure how much risk ESG factors pose to a company’s enterprise value. Each company in the portfolio is graded on an open-ended scale relative to others in its global industry peer group, with scores typically from 0 to 50—the lower the score, the better.

To receive an ESG score, at least 67% of a portfolio’s assets under management must have a company ESG score.

Rating Methodology

My sustainability ratings follow a five-step process. First, I determine if the fund qualifies for a rating: at least 67% of the companies in the portfolio’s assets under management must have an ESG score. Then, the portfolio score subtracts points for any ESG-related events, like oil spills or discrimination lawsuits.

Next, I calculate corporate and sovereign sustainability scores. The corporate score shows how much a company’s value is affected by ESG factors—the greater the risks, the more negative the impact. The sovereign score assesses a country’s socioeconomic risks and resource management; countries with inequalities, poor infrastructure, or resource shortages get higher, worse scores.

Then, I calculate historical scores by taking a weighted average of the previous 12 months for each fund, emphasizing more recent data. A fund investing in poorly rated countries or high-risk companies gets a lower overall score.

After that, I rank each fund’s corporate and sovereign historical sustainability scores against all scored funds in the same Morningstar category, requiring at least 30 eligible funds for ranking.

Continued Methodology

Finally, I adjust the ratings by weighing corporate and sovereign factors, sum them up, and round to the nearest whole number for the fund’s final sustainability rating.

Morningstar Star Rating vs. Sustainability Rating

According to my data, funds with higher sustainability ratings often have higher-quality holdings—they're more likely to get favorable analyst views, be less volatile, and invest in financially healthy companies with economic moats.

But a fund can have a high star rating and a low sustainability rating. For instance, Fidelity’s Total Market Index Premium fund has a four-star rating for risk-adjusted returns, and my analysts call it a great choice for diversified U.S. stock exposure due to its low cost and broad coverage. It also has a gold rating, meaning we expect it to outperform over a full market cycle. Yet, it only gets two globes for sustainability, based on an 80% ranking in its category and a score of 45.

Sustainable, Responsible, and Impact Investing Alternatives

My sustainability ratings let you tilt your portfolio toward sustainability without relying on sustainable, responsible, and impact (SRI) funds, which have drawbacks like representing a small part of the fund universe and facing hesitation from retail investors.

Using these ratings, you as a retail or institutional investor can choose between similar funds. If you're deciding between two large-cap growth funds with comparable performance and strategies, one with two globes and another with four, the globe rating could be your tiebreaker.

What Is a Good Morningstar Sustainability Rating?

The higher the rating, the better it is for you. Five globes mean the fund’s investments are very ESG-friendly, while one globe is the worst. Three globes is average, so four globes could be considered good.

Which Companies Provide ESG Ratings?

I'm not the only one scoring investments on ESG—others include MSCI, Bloomberg, Refinitiv, and credit agencies like Moody’s, S&P, and Fitch.

Which Company Has the Best ESG Report?

This depends on the ranking method you prefer. I use analysis from Sustainalytics to list top ESG companies; in the 2024 global top-50, U.S. firms include the Inter-American Development Bank, Keysight Technologies, and Universal Display.

The Bottom Line

You, as an investor, are increasingly focusing on ESG characteristics, seeking companies that address climate change, treat employees well, and avoid excessive executive pay. My Morningstar Sustainability Rating meets this need by showing how fund-held stocks perform on ESG within their peer groups.

Qualifying mutual funds and ETFs get rated from one to five globes based on their investments' ESG rankings. The higher the rating, the more ESG-friendly the fund is.