Morningstar - Q3 2021 - 36

Spotlight: Integrating ESG
EXHIBIT 6
Performance Comparison The returns of the ESG-aware and non-ESG portfolios were similar, although the ESG portfolio captured
less of both the upside and the downside of its category index than did its counterpart.
1 Year
(June 2020-May 2021)
Total Return, Risk-Adjusted Return, and Alpha
ESG-Aware Portfolio
Non-ESG Portfolio
Total
Return
(%)
Sharpe
Ratio
(%)
26.63 2.81
28.50 2.66
Morningstar Moderate Target Risk Index 25.54 2.50
US Fund Allocation-50% to 70% Equity
28.28 2.53
Alpha vs.
Category
Index (%)
2.92
1.82
0.00
1.88
3 Year
(June 2018-May 2021)
Total Return
(% Annlzd)
11.13
11.71
10.93
10.74
Sharpe
Ratio
(% Annlzd)
0.87
0.85
0.86
0.77
Alpha vs.
Category
Index
(% Annlzd)
0.25
0.01
0.00
-0.81
COVID-19 Recovery
(April 2020-May 2021)
Total
Return
(% Annlzd)
42.69
46.13
43.08
45.09
Sharpe
Ratio
(% Annlzd)
3.24
3.04
2.92
3.08
COVID-19
Sell-Off
(Feb.20-March
23, 2020)
Calendar-Year Returns
2020
Total Return
(%)
Annual
Return
(%)
2019
Annual
Return
(%)
2018
Annual
Return
(%)
-22.97 12.96 19.43 -5.08
-24.14 13.23 21.27 -5.29
-22.79 12.82 19.03 -4.76
-24.20 11.72 19.23 -5.76
1 Year
(June 2020-May 2021)
3 Year
(June 2018-May 2021)
Upside Capture and Downside Capture
ESG-Aware Portfolio
Non-ESG Portfolio
Morningstar Moderate Target Risk Index
US Fund Allocation-50% to 70% Equity
Source: Morningstar Direct. Data as of 06/03/2021.
Upside Capture vs.
Category Index (%)
98.91
106.83
100.00
106.14
Downside Capture vs.
Category Index (%)
69.27
85.44
100.00
101.75
Upside Capture vs.
Category Index (%)
98.99
106.33
100.00
104.43
Downside Capture vs.
Category Index (%)
96.32
105.63
100.00
110.96
COVID-19 Recovery
(April 2020-May 2021)
Upside Capture vs.
Category Index (%)
98.54
106.69
100.00
106.24
Downside Capture vs.
Category Index (%)
69.27
85.44
100.00
101.75
the same periods, the ESG portfolio lagged
its non-ESG counterpart in terms of total returns,
but it outperformed on a risk-adjusted basis
and delivered superior alpha. Both portfolios
lagged the Morningstar category index during the
COVID-19 market sell-off (Feb. 20 to March
23, 2020), though the non-ESG portfolio suffered
a greater drawdown than its ESG counterpart.
In general, as the exhibit shows, the ESG
portfolio has captured less of the upside than
its non-ESG counterpart, but it has captured less
of the downside, too.
Fees are comparable, though the ESG portfolio
costs 2 additional basis points on an assetweighted
basis. The non-ESG portfolio costs 43
basis points, so the ESG portfolio increased
the cost to 45 basis points. This is mostly
the result of swapping the Fidelity and Vanguard
index funds for active vehicles. In other asset
classes, such as large value and foreign large
36
Morningstar Q3 2021
blend, achieving ESG objectives entailed a switch
to passive from active, and fees came down
as a result. Overall, the ESG portfolio leans more
heavily toward passive strategies, with
35% of assets invested in index funds versus
the non-ESG portfolio's 17.5%.
These are the kinds of trade-offs advisors
must scrutinize with their clients when deciding
the degree to which they want to prioritize
assembling an ESG portfolio.
Conclusion
The growing interest in sustainability among
investors means that advisors are increasingly
likely to encounter opportunities to help
clients transition to ESG-friendly portfolios. The
fund industry has matched this growth in
interest with an ever-expanding set of investment
options stretching across asset classes and
strategy types. This does not mean the job is
simple: There are competing definitions of
ESG investing and many nuances to how fund
managers implement their ESG strategies
(not to mention varying degrees of success in
achieving financial and ESG goals). As we
have demonstrated in this case study, a careful
analysis of both the client's current non-ESG
portfolio and the available fund universe
enables construction of a well-diversified portfolio
that achieves favorable outcomes for both
ESG and financial objectives. As ESG fund options
continue to increase and ESG data continues
to deepen, the outlook for transforming portfolios
will only improve. K
Josh Charlson is director, manager selection, with
Morningstar Research Services LLC.
Alyssa Stankiewicz is a sustainability analyst with
Morningstar Research Services LLC.

https://www.morningstar.com/authors/239/josh-charlson

Morningstar - Q3 2021

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