If the idea of environmental, social and governance (ESG) risks has been well telegraphed, they can still lurk in unexpected parts of your portfolio. That’s the message from a new Morningstar paper, which warns that stocks in some sectors presumed to be ESG-friendly can be far from it.
Analysis of Morningstar’s equity indices found that the firm’s Global Markets Renewable Energy index was roughly 10 times more carbon-intensive than the broader market, judged by companies’ reported emissions. Those flagged include solar company Sunrun (US:RUN) and construction tech firm Schweiter Technologies (SWI:SWTQ) on top of “carbon-intensive companies as China Power (HK:02380), RWE (GER:RWE) and AES (US:AES)”.
Morningstar also highlighted high-risk companies in terms of governance like Tesla (US:TSLA), which has labour challenges and Elon Musk’s (pictured) unique management style to contend with. “Though Tesla’s electric cars are emissions-free, the company faces other ESG-related risks,” noted Morngstar analyst Dan Lefkovitz.
Tesla is not a problem for the Morningstar index alone: MSCI’s SRI indices can include the stock, leading to its presence in stricter ESG exchange-traded funds (ETFs), while Baillie Gifford’s Positive Change investment team is known for backing the carmaker.
Other investment approaches not associated with problematic sectors can carry their own hidden risks. Broadly speaking, high allocations to utility stocks and industrials can lead investors to carbon-intensive and “high ESG-risk” stocks. Morningstar’s Global Equity Infrastructure index came with a carbon intensity score of 1078.85, well above the 138.07 given to the broad equity market.
Investors looking for a smoother investment journey may encounter their own problems: the research firm noted that its US Minimum Volatility index had racked up substantial carbon intensity by having more than double the exposure to utilities and basic materials stocks than the broader market. Stocks in the index included utility American Electric Power (US:AEP) and miner Southern Copper (US:SCCO).
Not all of the investment approaches flagged as carbon-intensive will come as a surprise, with high dividend yield funds tending to fall foul of such metrics due to their reliance on energy stocks. But Morningstar found that a dividend portfolio could carry almost 20 per cent more ESG risk than the overall market. That said, not all dividend strategies are the same.
If Morningstar’s Dividend Yield Focus index looks problematic on the sustainability and carbon intensity front due to its inclusion of names like Exxon (US:XOM) and Chevron (US:CVX) and utilities names such as Duke Energy (US:DUK), a portfolio with a more cautious approach to yield fares better.
“Dividend growth, which targets tomorrow’s dividend leaders, has less exposure to carbon-intensive sectors,” Lefkovitz said. However, even a dividend growth index had exposure to companies with weak ESG scores, from Microchip Technology (US:MCHP) to Worthington Industries (US:WOR).
