Style risk is one of the key risks that sustainable investors need to be aware of. After all, many equity funds with a sustainable mandate tend to lean towards a growth style. Any choice of style brings the likelihood of it falling out of favour with investors over a period of time. So too this year’s growth style.
One of the risks of SRI is style risk. Perhaps many investors are not aware of it, but by integrating sustainability into investment policy, a portfolio quickly tends towards a growth style. Not entirely coincidentally, we therefore find relatively many sustainable equity funds in growth-style categories, such as Global Large-Cap Growth Shares or Europe Large-Cap Growth Shares. At the same time, growth-style portfolios often have a more sustainable profile, even if sustainability is not specifically part of the investment policy.
To illustrate, the Morningstar category Global Large-Cap Growth Equities has a total of 565 funds and 135 of them have an explicit sustainability mandate, or almost 24 per cent. In contrast, the Global Large-Cap Value Equity category has 161 funds. Of these, 20 funds have SRI policies, or about 12 per cent. The number of SRI funds is thus much more limited in both absolute and relative terms in the value category than in its growth counterpart.
This is partly due to the type of companies in which SRI funds generally invest. These have to meet (high) sustainability requirements. These are often also companies that meet quality criteria such as high return on equity or invested capital, high profit margins, low leverage and strong management. Such companies are often found in high-growth industries.
Energy and utilities companies
Value stocks, defined as those with a low valuation, are often found in industries with little or no growth and also more likely to be involved in less sustainable or even (environmentally) polluting activities. This is also reflected, for instance, in the sector allocation of portfolios with a value or growth style. For instance, the MSCI World Growth index has an allocation of 1.52 per cent to the energy sector and 0.25 per cent to utilities. In contrast, the MSCI World Value index has almost 10 per cent and over 5 per cent to these typical value sectors, respectively.
The risk associated with investing in a particular investment style is that it can fall out of favour with investors for a period of time. The result: underperformance relative to the broader market or other styles. An additional risk is that this period of underperformance does not usually take the form of a short dip, but can sometimes be relatively long. Sustainable investors would therefore do well to be aware of the style of mutual fund they are (or will be) investing in.
Just how important the choice between the two styles can be made clear in recent years. In 2020, for instance, the MSCI World Growth index achieved a gain of 22.78 per cent, while the MSCI World Value index suffered a loss of 9.33 per cent. Over the first 10 months of this year, those roles have reversed and the value index stands at a cautious plus of almost 3 per cent, while the growth index lost almost 19 per cent of its value.
Top 5
This week’s top five lists the five global value equity funds (of which a distribution fee-free share class is available in the Netherlands) that have the best Morningstar Portfolio Corporate Sustainability Score. This sustainability rating is an asset-weighted average of Sustainalytics› corporate-level ESG risk score. The ESG risk score measures the extent to which a company’s economic value may be compromised by ESG factors. Like ESG risk scores, the Portfolio Corporate Sustainability Score is displayed on a scale of 0 to 100, with lower scores being better.
Schroder ISF Global Sustainable Value has the best sustainability score among global value equity funds. The fund is still very young, having only seen the light of day in December last year. Since then, it has been managed by the trio Roberta Barr, Liam Nunn, and Simon Adler. They are part of the Schroder Global Value team that manages multiple global and regional value and dividend strategies and consists of 11 managers and analysts.
In addition to this fund, Nunn and Adler are also involved in managing Schroder ISF Global Recovery, which has a Morningstar Analyst Rating of Bronze for its distribution fee-free share class and a People Pillar score of Average. This sustainable strategy invests in value stocks of companies seen by the team as sustainability leaders within their respective industries.
The portfolio is concentrated with only 37 positions, but it also has concentrations at the sector level. For instance, it is notable that the communications services sector has a weighting of 26 per cent, while the financial services (22.18 per cent) and technology (15.09 per cent) sectors also have significant allocations. Meanwhile, the portfolio has no exposure to commodities, energy and utilities, while the managers hardly invest in industrial companies at all.
In fifth place is Nordea 1 - Global Stable Equity that carries a Morningstar Analyst Rating of Bronze. This quantitative approach has been implemented since 2005 by experienced duo Claus Vorm and Robert Naess who are also the founders of the strategy. The absolute focus is on stable earnings and low or moderate stock price volatility. Although the strategy has no explicit sustainability mandate, ESG scores of companies are nevertheless considered. The quantitative approach has a strong bias towards defensive companies and the communications and healthcare sectors are therefore heavily overweight. While the ESG criteria do not keep the approach away from commodity and utility companies, the energy sector is completely absent.
Ronald van Genderen is senior manager research analyst at Morningstar. Morningstar analyses and evaluates investment funds based on quantitative and qualitative research. Morningstar is one of Investment Officer’s knowledge partners and ranks five mutual funds or providers every week.