Morningstar finds no yield penalty in ESG income funds

In 2018, dedicated ESG income funds were a rare commodity. There are now 40 on the market, collectively managing about $28 billion. A few years of growth have produced a track record, and Morningstar has crunched the numbers. The research, reported by Net Zero Investor, shows ESG income funds delivered both ESG and income.

The central finding is that ESG strategies did not carry a yield discount relative to conventional peers. For investors whose income mandates carry sustainability screens, that is the point. Morningstar puts the segment in mature terms, calling it "structurally relevant" to the global income category, "underpinned by a stable asset base, a diversified set of providers, and an established footprint that is unlikely to unwind."

Behind that language sits an allocator-friendly reality: 40 funds, $28 billion in assets, a diversified set of providers. The category has stopped being an experiment. The growth spurt ran through 2022-2023, when ESG funds accounted for 13% of the global income category.

Inside the portfolios, the data show the screens working. On average, three-fourths of total assets in ESG income portfolios carried a low or negligible degree of ESG risk. Carbon risk metrics point the same direction: 72% of global ESG income funds hold a higher allocation to low-carbon-risk assets.

The mechanism is negative selection. ESG income funds apply exclusion screens for thermal coal, alcohol, tobacco, military contracting, and nuclear, and they lean on those screens more than conventional income funds do. The report concludes that ESG funds "primarily reduce exposure across key controversial categories such as alcohol, thermal coal, tobacco, military contracting, and nuclear."

Exclusion is not the same as explicit climate investing. Renewable and battery makers do not follow automatically from dropping carbon-intensive holdings. Instead, ESG income strategies typically hold more healthcare, real estate, and technology companies. The funds are defined as much by what they refuse as by what they own.

Regionally, the market remains uneven. Europe holds the bulk of ESG assets globally, the U.S. is not far behind, and Asia and the U.K. have ground to make up, according to Henry Ince, a Morningstar fund analyst for equity strategies and one of the report's authors.

For private wealth managers running income sleeves, the study swats away one objection: that sustainability screens force a dividend discount. It also raises a forward question. The data cover a period of rising rates and stable equity income. The next test comes when yields compress, and income managers feel pressure to reach into lower-quality debt or the dividends that screening would remove. Whether the no-trade-off result survives that environment is not something this report answers.