The latest edition of the Morningstar Sustainability Atlas finds, on the whole, that Northern Europe leads the way when it comes to corporate-level sustainability, with Finland taking top spot overall.
Portugal scored the highest on environment, followed by Denmark for social criteria, and the Netherlands for governance. On the other end of the spectrum, author Valerio Baselli finds China at the bottom of the rankings across all three ESG criteria.
Canada’s sustainability score dragged down an otherwise average ESG performance.
Canada has an overall sustainability score of 47.03, which puts it in the fourth quintile globally. “Canada is a middle-quintile performer on ESG criteria, ultimately placed in the fourth quintile for its sustainability score, owing to controversies from some of the country's largest companies, like Royal Bank of Canada (RY) or The Toronto-Dominion Bank (TD),” Baselli says. TD, for example, is considered by Sustainalytics an ESG outperformer among diversified banks, but at the same time it shows a significant level of controversies.
“The bank continues to service the defense industry and continues to finance projects with negative environmental impacts. Until it withdraws from financing companies related to nuclear weapons, palm oil, and gun manufacturing, it is likely to continue being cited by civil society groups for these activities, contributing to the ongoing level of reputational risks,” he points out.
The atlas uses the constituents of Morningstar Country Indexes to examine the sustainability profiles of 46 global equity markets. The company-level scores are sourced from Sustainalytics, which also powers the Morningstar Sustainability Rating for funds. Investors can use this data to identify countries with the greatest ESG investment opportunities and most significant risks. They can also track their ESG-related Portfolio Controversy Scores with this data.
Finland takes the title of the world’s most sustainable stock market thanks to holdings like Nokia (NOK), an ESG leader within the global technology hardware industry, and KONE (KNYJF), an ESG leader in the machinery sector. Columbia is the highest-scoring non-European market, thanks to ESG-leaders like Bancolombia (CIB), Ecopetrol (EC), and Cementos Argos (CMTOY). However, the report warns that the Colombian market also shows great carbon risk, or a high degree of risk to corporate value as a result of the transition to a low-carbon economy.
China, Russia, and Middle Eastern countries assume the lowest sustainability ratings. China, in particular, was found to have poor corporate governance from companies like Alibaba (BABA) and Tencent (TCEHY).
Controversies dent performance
Sustainalytics defines a controversy as any incident that has an impact on the environment or society, and therefore poses a risk to the responsible company and its overall sustainability performance.
The atlas shows the level of impact of these events. For example, Baselli notes, Switzerland scores very well on global ESG criteria (ranking third out of 46), but the number of controversies involving key companies such as Novartis (NVS) and Nestlé (NSRGF) ostensibly lower its overall sustainability score, so that it comes in much lower—at 12th—on that rating scale. The same is true for Brazil, an upper-middle performer on ESG criteria that ultimately placed in the bottom half for overall sustainability score, due to controversies from some of the country’s largest companies, like Vale and Petróleo Brasileiro.
Canada, again, scores poorly on the Controversy score, placing in the fourth quintile of countries, with a score of 5.57. It also, surprisingly, has a poor social score of 49.19, placing again, in the fourth quintile.
“It is true that Canada performs surprisingly poorly on social criteria, owing to companies like Nutrien (NTR), Alimentation Couche-Tard (ATD.A), and Waste Connections (WCN). The latter, for example, does not have a policy on freedom of association. Besides, considering its preparedness measures and involvement in controversies, it is viewed as having weak management of community relations,” Baselli points out.
Unsurprisingly, Canada has a low carbon score. “As per the Carbon intensity score, this comes as no surprise, given that Canada is a fossil fuel-heavy economy (Canada is the fifth-largest producer of natural gas and the sixth-largest producer of crude oil in the world with extensive oil and natural gas reserves across the country). Of course, this plays a pretty big role also in terms of environmental score,” Baselli says.
Good on governance
Canada scored better on governance, placing in the second quintile with a score of 57.56.
“Among the three pillars, the one in which Canada obtains the best result is corporate governance. Royal Bank of Canada is considered a leader in terms of corporate governance, and Sustainalytics highlights the quality of the board, the overall shareholder support and the remuneration policy as being the highlights of its good governance,” Baselli says. He says that the same goes for Enbridge (ENB), thanks to its very strong whistleblower program, as well as its bribery and corruption policy.
Our southern neighbor, the U.S., ranks in the fourth quintile of global sustainability leaders due to a significant level of controversy from big index constituents like Amazon (AMZN), Apple (AAPL), or Microsoft (MSFT), and poor governance scores from companies like Facebook (FB) and Alphabet (GOOGL).
But what does all of this mean in terms of investing? Many investors fear a negative impact on returns if they invest sustainably. Yet, the empirical evidence tells us quite a different story.
Jon Hale, Global Head of Sustainability Research for Morningstar says that most careful research that's been done over the past 20 years now has shown that ESG can enhance performance and is not a detractor from performance. “Investors should, in fact, demand financial performance alongside the idea that they are putting their money towards companies that are going to contribute to a more sustainable future,” Hale says.
Hence, claims that investors need to surrender returns to engage in sustainability are flawed. Sustainable investing serves as a positive force to drive returns and is not a fundamental drag on performance at the market level. Finally, where can you invest? Morningstar analyst Joe Gemino recently found Enbridge is a rare triple threat, boasting a wide moat, an attractive 6.8% dividend yield, and a cheap valuation.
