Do “Good Guys” Finish Last? The Relationship between Morningstar Sustainability Ratings and Mutual Fund Performance

Abstract

Given the rapid growth of investment products focused on socially responsible investing (SRI), in March 2016, Morningstar began reporting standardized metrics to “grade” the sustainability (i.e., SRI) level of thousands of mutual funds. By analyzing this new metric, the authors aim to help clarify the ongoing debate surrounding whether SRI positively or negatively affects investor returns. They find that funds with high sustainability scores have about the same risk-adjusted returns (i.e., alphas) as other funds. Thus, SRI investors can apparently follow a social mandate without sacrificing financial performance, but also without garnering any incremental financial benefit as well. They find, however, that the vast majority of high sustainability funds are concentrated in the large-cap space, which implies that strict adherence to social criteria could inadvertently result in less diversified investor portfolios. They also find that funds with high Morningstar sustainability scores generally mimic those of self-proclaimed SRI funds, suggesting that the new metric opens up a larger pool of potential funds for investors focused on SRI. Lastly, they find that funds that specifically designate and market a social mandate experience more stable cash flows; therefore, the self-proclaimed mandate may be more beneficial for the fund company than it is for investors.

TOPICS: ESG investing, portfolio theory, portfolio construction