What Is ESG Investing?
The objective of any investment is to achieve growth. But what if you can grow your assets and at the same time be socially responsible? Such options have gained traction recently in the form of SRI (Socially Responsible Investment) and ESG (Environmental, Social and Governance) investing. Oftentimes SRI and ESG are used interchangeably; however, there is a slight difference between the two. SRI avoids investing in companies or industries that negatively impact the environment or population. For instance, SRI would avoid investing in industries or companies engaged in making alcohol or tobacco or in companies engaged in production of weapons. So what is ESG investing? While ESG considers socially responsible frameworks like SRI, it is more about how these factors affect the investment performance.
ESG Investing – Environmental, Social, Governance
ESG, assesses three factors as listed below.
Environmental – issues related to air quality, energy usage, water quality
Social – community impact, labor, equal employment, product safety
Governance – executive diversity, corporate transparency, business ethics
ESG investing has been gaining momentum in the last ten years. More and more investors started to align their investment objectives and personal values increasing money flow into ESG funds and ETFs. For instance, assets under management (AUM) in ESG funds and ETFs in 2019 went up to $140 billion from $80 billion in 2018 according to Morningstar report.
Moreover, the traditional funds and ETFs started focusing on ESG factors. Morningstar calls these funds ESG consideration funds. These funds do not entirely focus on sustainability rather consider ESG factors in investment strategy. According to the Morningstar report, there were 564 ESG consideration funds with $933 billion in assets under management at the end of 2019.
The data from various investment companies indicate that the demand for ESG funds to go up considerably world-wide over the next few decades.
One of the common questions often asked is about the return from ESG investing. Am I sacrificing returns by investing in ESG funds?
Does ESG investing sacrifice investment return?
Let’s delve into the data to find out.
All major mutual fund companies offer ESG funds. For example,
- Vanguard ESG U.S. Stock ETF (ESGV)
- Fidelity U.S. Sustainability Index Fund (FITLX)
- BlackRock iShares ESG MSCI USA (ESGU)
The stocks in these funds are chosen based on the fund’s ESG criteria. For instance, Vanguard ESG U.S. Stock Fund excludes stocks of companies in adult entertainment, alcohol, tobacco, weapons, fossil fuels, gambling, and nuclear power industries.
Since all three ESG funds fall under the “large blend” category, I have compared them to one of the largest funds in the “large blend” category, Vanguard Total Stock Market Index Fund (VTSAX).
| Fund | ESGV | FITLX | ESGU | VTSAX |
| Total Assets | $ 2.7 billion | 568.2 million | 12.6 billion | 191.1 billion |
| No. of Holdings | 1461 | 288 | 348 | 3591 |
| Expense Ratio | 0.12% | 0.11% | 0.15% | 0.04% |
| Top 10 | 27.00% | 31.00% | 26.00% | 23.00% |
| Apple | Microsoft | Apple | Apple | |
| Microsoft | Alphabet Inc Class C | Microsoft | Microsoft | |
| Amazon | Alphabet Inc A | Amazon | Amazon | |
| Johnson & Johnson | Alphabet Class A | |||
| Alphabet Inc Class C | Procter & Gamble | Alphabet Class A | ||
| Alphabet Inc A | Nvidia | Tesla | Alphabet Class C | |
| Procter & Gamble | Visa | Alphabet Inc C | Bershire Hathway | |
| Visa | Tesla | Johnson & Johnson | Johnson & Johnson | |
| JPMorgan Chase | The Home Depot | Procter & Gamble | Procter & Gamble | |
| Nvidia | Mastercard | Nvidia | Visa |
As you can see, the top ten companies across all four investments are similar. Therefore, you do not expect much deviation in performance amongst the four investments as illustrated below.
| ESGV | FITLX | ESGU | VTSAX | |
| Inception | 9/18/2018 | 5/9/2017 | 12/1/2016 | 11/13/2000 |
| 2017 | – | – | 21.07 | 21.17% |
| 2018 | – | -3.28 | -4.22 | -5.17% |
| 2019 | 33.37 | 31.53 | 31.21 | 30.80% |
| YTD | 21.69 | 15.37 | 19.33 | 17.31 |
Summary
ESG is not yet a traditional factor such as value, size or momentum. With change in investors behavior in aligning their portfolios with personal values and beliefs, more money is expected to flow into ESG investment Would ESG funds generate returns in line with traditional funds over a long period of time? At least in the short-term, two of the three ESG investments in this article are outperforming traditional fund, VTSAX, by a few percentage points. However, three ESG funds have relatively short history compared to VTSAX.
According to this Morgan Stanley report, “the returns of the sustainable funds are in line with those of traditional funds.” The research conducted on performance of 11,000 mutual funds from 2004 to 2018. The time will tell if ESG investments return are comparable to a traditional investment.
One cautionary note about ESG is that there are no standards or guidelines regarding the definition of ESG. In addition, ESG disclosure is voluntary. Without any regulations or guidelines, the quality of information and complete disclosure regarding ESG may not be accurate.
ESG investing is a great way to align your portfolio to reflect your values. Is it worth it? Maybe a combination of traditional fund and ESG fund until ESG investments establish a long track record?
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