Morningstar - Q3 2021 - 35

EXHIBIT 5
underrepresentation of ESG funds in certain
asset classes and categories; the ESG-unfriendly
nature of certain common asset classes
(such as real estate and value equity); and the
incomplete nature of Morningstar's current
ESG Commitment Level coverage. These
are the realities that any advisor or investor will
face in transitioning to a more sustainable
portfolio, and as such, it is important to reflect the
state of affairs in our case study. At times,
compromises can be made, such as selecting
a fund with a high globe rating that doesn't
target a sustainability mandate. In other
cases, such as Treasury Inflation-Protected
Securities, there is currently no ESG-friendly
alternative available.
Fund swap decisions were made at the
individual fund level, but we had portfolio-level
ESG goals, as well. In particular, we wanted
the ESG-aware portfolio to demonstrate a much
higher level of intentionality, a higher average
Sustainability Rating, increased use of
exclusionary screening, a lower Carbon Risk profile,
a strong presence of funds with favorable
ESG Commitment Levels, and some inclusion
of active impact investment mandates. And we
wanted to achieve these goals while
maintaining high investment-quality standards.
EXHIBIT 3 shows our hypothetical client's new
ESG-aware portfolio.
How'd We Do?
EXHIBIT 4 shows the sustainability profile of
the new ESG-aware portfolio. On the intentionality
front, from a portfolio of zero intentionally
sustainable strategies, we now feature a portfolio
where seven of 12 funds have intentional
mandates, representing 88.5% of the overall
portfolio's assets. Similarly, seven funds in the ESG
portfolio employ three or more of our desired
values-based exclusions.
We significantly reduced ESG risk, as well.
Forty-four percent of assets are in funds with
4- or 5-globe ratings compared with 25.5%
in the non-ESG portfolio. The remaining 16% of
eligible assets earn an Average Morningstar
Sustainability Rating. (This rating does
not apply to bond funds.) The carbon footprint
Greener Metrics A side-by-side comparison shows how much we were able to
improve the portfolio's sustainability profile.
Non-ESG Portfolio
Assets (%)
Intentionally Sustainable Funds
Funds Excluding 3 or More Controversial Businesses
Funds With Low ESG Risk (4-5 Globes)
Funds With High ESG Risk (1-2 Globes)
Funds Earning the Low Carbon Designation
Funds Earning a High ESG Commitment Level (Advanced or Leader)
Source: Morningstar Direct. Data as of 06/03/2021.
0.0
0.0
25.5
24.0
12.0
0.0
ESG Portfolio
Assets (%)
88.5
88.5
44.0
0.0
48.5
50.5
of the new portfolios is also improved. Five
funds in the ESG-aware portfolio earn the Low
Carbon designation.
We were able to double the number of funds
receiving coverage under the Morningstar
ESG Commitment Level to six. Among them,
Parnassus Core Equity PRBLX, Parnassus Mid-Cap
PARMX, and TIAA-CREF Core Impact Bond
TSBIX earn an ESG Commitment Level of Leader,
signifying an industry-leading commitment
to integrating ESG data, resources, and investment
principles. Calvert US Large Cap Value Responsible
Index CFJIX, Calvert International Responsible
Index CDHIX, and iShares ESG Aware MSCI EM
ETF ESGE receive ESG Commitment Levels of Basic,
indicating at least some degree of ESG
incorporation. As asset managers, Parnassus,
Calvert, and Nuveen, a TIAA company, earn ESG
Commitment Levels of Advanced or Leader,
indicating impressive resources and commendable
active ownership practices.
As far as active impact investments, note that
TIAA-CREF Core Impact Bond, the core-bond
selection that accounts for 33% of assets, devotes
about 30% to 40% of its portfolio to impact
investments-bonds issued to finance
a project explicitly targeting ESG outcomes.
In sum, despite some limitations in a few asset
classes, the client will see marked improvements
in overall level of ESG risk, alignment
with values, carbon footprint, intentionality
and commitment to ESG mandates, and exposure
to impact investments. EXHIBIT 5 compares
the two portfolios.
It's important to note that there are some
trade-offs made in the effort to improve the
sustainability profile of the portfolio. Whereas the
original portfolio contained five Gold-rated
funds, five Silver-rated funds (of which one
is a Morningstar Quantitative Rating), and one
Bronze-rated fund (the money market fund
does not receive a rating), the new ESG portfolio
drops to two Golds, four Silvers, and five
Bronzes. Nevertheless, all funds in both portfolios
are Morningstar Medalists, indicating our
analysts' confidence in the funds' ability to
outperform their benchmarks on a risk-adjusted
basis over the long term.
Deeper Dive
Both the ESG portfolio and the non-ESG portfolio
target a 60%/40% split between stocks and
bonds. Therefore, the relevant peer group for both
portfolios is the Morningstar allocation-
50% to 70% equity category, and the relevant
benchmark for returns is the Morningstar
Moderate Target Risk Index-a 60%/40% equity/
bond split. EXHIBIT 6 shows that the performance
versus this category index is strong for both
the ESG-aware and non-ESG portfolios.
Both sample portfolios outperformed the bogy
on a total and risk-adjusted basis, as measured
by the Sharpe ratio, for the trailing oneand
three-year periods, ended May 2021. Over
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