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Sustainable Moat Investing: Considering Controversy

15 July 2022

 

Morningstar® US Sustainability Moat Focus IndexSM combines Morningstar’s recognized equity research process of identifying companies with long-lasting competitive advantages and attractive valuations with Sustainalytics’ industry-leading ESG research. The Index focuses on three proprietary ESG criteria when selecting companies for inclusion: ESG Risk, Controversy, and Carbon Risk. Here we will explore the Sustainalytics Controversy Score.

Morningstar US Sustainability Moat Focus Index Methodology

Morningstar US Sustainability Moat Focus Index Methodology

  • ESG RISK: Companies must have an ESG Risk Rating categorized as medium, low or negligible.
  • Controversity: A company´s controversy score must be 4 (out of 5) or lower throughout the trailing three years.
  • Carbon Risk: A company´s carbon risk score cannot be high or severe.
  • Product Involvement: A company must not be involved in tobacco, controversial weapons, civilian firearms, thermal coal.
  • Wide Moats: Only those companies that Morningstar equity research analyst have assigned a wide economic moat rating are eligible for inclusion.
  • Attractive Valuations: Select the most attractively priced wide moat companies based on a companies current price relative to its Morningstar analyst-assigned fai value estimate.

Source: Morningstar and VanEck. As of 30/9/2021.

Sustainalytics Controversy Score

Sustainalytics assesses companies’ involvement in incidents with negative environmental, social, and governance (ESG) implications. Controversy involvement can be a key measure of the ESG performance of a company and may help inform investment decisions.

The Controversy Score seeks to identify incidents and events that may have a negative impact on a company’s reputation. It examines the financial risk to a company resulting from incidents and how a company has responded to the incidents to determine the severity of the controversy.

Incidents and Events

Sustainalytics monitors incidents which are a key building block of their Controversy Score. Incidents are company activities that have negative ESG impacts on stakeholders. They are assessed based on the negative impact as well as the reputational risk that the incident poses to the company. Incidents are tracked through media and non-government organizations.

Events are a series of isolated or related incidents that pertain to the same ESG issue. Sustainalytics has 40 event indicators. For example, a series of employee strikes in various company locations forms an event under the “Labor Relations” event indicator.

To assess an event, an analyst looks at the series of underlying incidents from a holistic perspective and assesses them based on the following factors:

  • Impact: Negative impact that the incidents have caused to the environment and society
  • Risk: Business risk to the company as a result of the incidents
  • Management: A company’s management systems and response to incidents

Controversy Scale

Events are assessed on a scale of five levels from low to severe. The Morningstar US Sustainability Moat Focus Index excludes those companies that have had a severe controversy score in the last three years.

Controversy Category

Controversy Category

  • Category 1 | Low: The Event has a low impact on the environment and society, and risks to the company are minimal or negligible.
  • Category 2 | Moderate: The Event has a moderate impact on the environment and society, posing moderate business risks to the company. This rating level represents low frequency of recurrence of incidents and adequate or strong management systems and/or company response that mitigate further risks.
  • Category 3 | Significant: The Event has a significant impact on the environment and society, posing significant business risks to the company. This rating level represents evidence of structural problems in the company due to recurrence of incidents and inadequate implementation of management systems or the lack thereof.
  • Category 4 | High: The Event has a high impact on the environment and society, posing high business risks to the company. This rating level represents systemic and/or structural problems within the company, weak management systems and company response, and a recurrence of incidents.
  • Category 5 | Severe: The Event has a severe impact on the environment and society, posing serious business risks to the company. This category represents exceptionally egregious corporate behavior, high frequency of recurrence, very poor management of ESG risks, and a demonstrated lack of willingness by the company to address relevant risks.

Source: Morningstar. As of 30/6/2022.

Controversy Case Study: Bayer AG1

Bayer is currently assigned a severe controversy score based on the social impact of their products, specifically glyphosate-based products such as Roundup. When Bayer acquired Monsanto in 2018, it acquired all the risks associated with Monsanto’s business in the agriculture chemistry industry. In 2015, the Word Health Organization classified glyphosate as potentially carcinogenic. In August 2018, the first liability lawsuit related to the product went to trial and Monsanto was ordered to pay $289 million to the plaintiff. Since then, lawsuits increased exponentially to at least 125,000 filed and unfiled claims by June 2020.

Sustainalytics assesses this Bayer controversy as severe due to the mounting stakeholder scrutiny over glyphosate-based products, the increase in glyphosate-related litigation as well as the increased number of countries that are imposing restrictions, and partial bans, or full bans on glyphosate-based products. While the company has been able to settle the majority of the pending lawsuits in the U.S., there is still uncertainty around the future of the glyphosate litigation process and the trend of potential liability lawsuits in the future.

A Sustainable Approach to Moat Investing

Many of the most popular sustainable investment strategies seek to offer broad exposure to market indexes while applying some level of exclusionary or inclusionary ESG screens. This may reduce ESG risk in a portfolio, but does not address other performance drivers. The Morningstar US Sustainability Moat Focus Index’s unique combination of forward-looking equity research and ESG screening offers investors a U.S. equity strategy that seeks to provide investors with attractive risk-adjusted returns while mitigating ESG risks.

1 Bayer AG is not eligible for the Morningstar US Sustainability Moat Focus Index as a non-U.S. company.

Important Disclosure

This is a marketing communication. Please refer to the prospectus of the UCITS and to the KID before making any final investment decisions.

This information originates from VanEck (Europe) GmbH, which has been appointed as distributor of VanEck products in Europe by the Management Company VanEck Asset Management B.V., incorporated under Dutch law and registered with the Dutch Authority for the Financial Markets (AFM). VanEck (Europe) GmbH with registered address at Kreuznacher Str. 30, 60486 Frankfurt, Germany, is a financial services provider regulated by the Federal Financial Supervisory Authority in Germany (BaFin).

The information is intended only to provide general and preliminary information to investors and shall not be construed as investment, legal or tax advice VanEck (Europe) GmbH, VanEck Switzerland AG, VanEck Securities UK Limited and their associated and affiliated companies (together “VanEck”) assume no liability with regards to any investment, divestment or retention decision taken by the investor on the basis of this information. The views and opinions expressed are those of the author(s) but not necessarily those of VanEck. Opinions are current as of the publication date and are subject to change with market conditions. Certain statements contained herein may constitute projections, forecasts and other forward-looking statements, which do not reflect actual results. Information provided by third party sources is believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. Brokerage or transaction fees may apply.

VanEck Asset Management B.V., the management company of VanEck Morningstar US Sustainable Wide Moat UCITS ETF (the "ETF"), a sub-fund of VanEck UCITS ETFs plc, is a UCITS management company under Dutch law registered with the Dutch Authority for the Financial Markets (AFM). The ETF is registered with the Central Bank of Ireland, passively managed and tracks an equity index. Investing in the ETF should be interpreted as acquiring shares of the ETF and not the underlying assets. Investors must read the sales prospectus and key investor information before investing in a fund. These are available in English and the KIIDs/KIDs in certain other languages as applicable and can be obtained free of charge at www.vaneck.com, from the Management Company or from the following local information agents:
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Morningstar® US Sustainability Moat Focus Index is a trade mark of Morningstar Inc. and has been licensed for use for certain purposes by VanEck. VanEck Morningstar US Sustainable Wide Moat UCITS ETF is not sponsored, endorsed, sold or promoted by Morningstar and Morningstar makes no representation regarding the advisability in VanEck Morningstar US Sustainable Wide Moat UCITS ETF.
Effective December 17, 2021 the Morningstar® Wide Moat Focus IndexTM has been replaced with the Morningstar® US Sustainability Moat Focus Index.
Effective June 20, 2016, Morningstar implemented several changes to the Morningstar Wide Moat Focus Index construction rules. Among other changes, the index increased its constituent count from 20 stocks to at least 40 stocks and modified its rebalance and reconstitution methodology. These changes may result in more diversified exposure, lower turnover and longer holding periods for index constituents than under the rules in effect prior to this date.
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