Morningstar - Q1 2020 - 9

season. According to research by Morningstar,
ESG resolutions drew the support, on
average, of nearly 30% of the shares voted
at the annual general meetings of U.S. companies.
That's the highest level of support over
the 16 years for which Morningstar has proxy
voting data.
Sustainable investors have also ramped up their
direct engagements with companies, taking
on ESG-related issues like guns, opioids, gender
equity, and climate change.
Many larger asset managers prefer to
engage privately with companies about ESG
issues and often oppose most shareholder
resolutions that bear on these same issues unless
they believe their engagement efforts have
failed. While every ESG resolution doesn't
necessarily deserve automatic approval, a blanket
policy of voting routinely against ESG resolutions
dilutes the influence sustainable investors can
have. Asset managers need to be more
transparent about communicating their ESG
engagements to shareholders. And those
that generally oppose ESG-related shareholder
resolutions need to reconsider that stance,
as more investors will use proxy voting to gauge
asset manager commitment.
A Partisan SEC Turns Back the Clock

Shareholder proposals are a critical means
of communications between companies and their
shareholders. Over the years, shareholder
resolutions have helped put ESG issues
on many companies' radars, helping them attend
to issues before they suffer the financial
consequences of ignoring them.
At a time when proxy voting and shareholder
engagement are becoming more central
to corporate governance, the SEC in the U.S.
is moving to limit these activities. During
last year's proxy season, the SEC was more willing
to allow companies to leave shareholder
resolutions off the proxy ballot because they
were deemed to be about ordinary business and
beyond the scope of shareholder oversight.

In November, the SEC voted 3-2, with Republican
commissioners in the majority, to raise the
thresholds for shareholders to propose resolutions
at annual company meetings and to increase
the thresholds for resubmitting such resolutions
in subsequent years. The commission also
proposes to limit the influence of proxy advisors,
which assist asset managers in the proxyvoting process.
The SEC rulemaking process remains under
way, subject to public comment, so the rules aren't
final. They are being pushed by Washingtonbased corporate trade groups closely aligned with
the three Republican commissioners,
who aren't pleased with the growing support for
shareholder proposals about climate risk
and better disclosures on corporate political and
lobbying expenditures.
Interest in Sustainable Investing Is Increasing

Every other year since 2015, Morgan Stanley
has surveyed individual investors about
their interest in sustainable investing. In 2015, 71%
indicated an interest. In 2019, 85% indicated an
interest (including 95% of millennials). And a much
greater proportion in 2019 said they were "very"
interested in sustainable investing: In 2015, only
19% said they were, but in 2019, 49% said so.
So, why hasn't that interest translated into
invested assets? Most individuals change their
investments infrequently, and often only when
a new occasion presents itself (an inheritance, for
example, or a large bonus). Many millennials
are still in the early stages of investing. Interest
in sustainable investing doesn't suddenly turn
people into investors. But when they are ready to
invest, they're going to do so sustainably.
A Bank of America report in September concluded
that a "tsunami of assets is poised to invest"
sustainably over the next two decades.4
Flows Into U.S. Sustainable Funds Are Rising

If not exactly a tsunami, a big wave of flows hit
sustainable funds in 2019. Estimated net flows
into open-end and exchange-traded sustainable
funds available to U.S. investors reached $17.7

billion through November. That's more than triple
the record for an entire calendar year, set in 2018.
Many More Funds "Considering" ESG

Over the past year, many conventional funds in the
U.S. have added ESG criteria to their prospectuses,
bringing the total to about 500. This trend reflects
the realization on the part of many asset managers
that consideration of material ESG issues results in
a more complete investment analysis. We expect
this trend to continue. Yet there is little evidence,
thus far, of whether ESG "consideration" is actually
having an impact on these funds. Fund managers
will need to do a better job showing that impact to
be credible with sustainable investors.
Enhancement to Morningstar Sustainability Rating

The enhanced Morningstar Sustainability Rating
was released in November, with a greater focus on
the financial materiality of ESG issues. It now
reflects both within-industry and across-industry
assessments of ESG risk. An overwhelming
majority of diversified sustainable funds receive
4 or 5 globes, far more than the percentage
of ESG consideration funds or conventional funds
that receive 4 or 5 globes. (See "Risk at Heart of
Improved Sustainability Rating," Page 34.)
Impact Investing Resonates

If ESG risk is one watchword of sustainable
investing, impact is the other. Making a difference
through one's investments resonates with people.
Funds that practice active ownership through
engagement and proxy voting can help companies
meet their sustainability challenges and lower
ESG risk while creating positive societal impacts
beyond financial returns.
Several explicitly impact-oriented funds launched in
2019, and I expect to see more in 2020. In addition,
I expect more asset managers to communicate
the societal impacts of their sustainable strategies.
Many of these will use the UN's Sustainable
Development Goals as a framework. K
Jon Hale, CFA, Ph.D., is director of sustainability research
with Morningstar Research Services. He is a member
of the editorial board of Morningstar magazine.

4 Bank of America. 2019. "10 Reasons You Should Care About ESG." Sept. 23, White Paper.

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Morningstar - Q1 2020

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