ESG (environmental, social, and governance) investing may be the buzzword du jour, but over the past couple of years it has established itself as a solid niche investment. More and more institutional investors are incorporating its principles into their investment selection process and putting ESG-focused assets into their portfolios.
Now it's individuals' turn, and the mutual fund and ETF industries have dutifully churned out dozens of new ESG-oriented products for investors who want to make money but also want to have a positive impact on the world.
Infographic: Green investing grows
Jon Hale, head of sustainability research at Morningstar, says there are now around 230 funds and ETFs that have an ESG or sustainability theme. That's a small fraction of the more than 8,000 mutual funds and 1,771 ETFs in existence as of September, according to the Investment Company Institute. But he says their number is growing rapidly—27 new ones this year and 62 launched in 2016. Of these, he notes, there were "proportionally more actively managed funds than in the industry as a whole, but there [were] definitely passive launches out there."
ESG investing has its roots in the socially conscious or socially responsible investing of years past, an approach Hale calls "considerably less sophisticated." SRI, he says, was more about making a statement or deciding which companies or products—e.g., tobacco, alcohol, fossil fuels—you didn't want to own.
But over the last few years, consultants and investors have developed more rigorous measurements of how to sustain corporate and natural resources, as well as foster transparency and responsive corporate governance. For its own sustainability ratings, Morningstar uses a firm called Sustainalytics to measure how companies are doing in that area. MSCI ESG Research does similar quantitative evaluations of companies and investment portfolios to make sure they meet ESG standards. Socially responsible investing did not have those tools.
Also, indexes that track the sector now have long enough records for investors to compare their performance with that of traditional indexes. The MSCI KLD 400 Social Index (formerly the Domini 400 Social Index) was launched in May 1990, giving it 27½ years of performance that include two long bull markets and two nasty bears.
From May 1990 through Oct. 31, the annual return of the MSCI KLD index almost exactly matched that of the broader MSCI USA Investable market Index, with nearly identical risk. That, says Hale, dispels one of the biggest myths about ESG investing: that you have to give up financial return in order to feel good about where you invest your money.
"The empirical evidence over the years is that those portfolios perform about as well as conventional ones," he told me. "My conclusion is, no, you don't have to give up return in order to invest this way." He says several academic studies support his findings.
Hale prepared a spreadsheet for MarketWatch that listed all the funds and ETFs in Morningstar's universe that have sustainability or ESG themes. I then screened for funds that had a four- or five-star long-term Morningstar rating for past performance and at least above-average sustainability grades. I removed funds that had a sales load (they still have them, yes), those in the institutional share class, and those that had high minimum investments ($100,000). I also removed almost all funds whose expense ratio was above 1%.
I was left with seven funds — five domestic and two international. (You can invest in ESG bond funds, too, but I focused on equity.)
|Name of Fund||Ticker||Morningstar category||Number of stars||Morningstar sustainability rating||Inception date||Net expense ratio (%)||1-year total return||Annualized 5-year total return||Annualized 10-year total return|
|Calvert Emerging Markets Equity I||CVMYX||Diversified Emg. Mkts||5||Above Average||10/31/2012||1.02||38.89||10.18||N.A.|
|Domini Impact International Equity Inv||DOMIX||Foreign Large Value||5||High||12/27/2006||1.46||24.56||11.02||13.18|
|Parnassus Endeavor Investor||PARWX||Large Growth||5||Above Average||4/29/2005||0.95||24.16||19.55||7.63|
|iShares MSCI KLD 400 Social ETF||DSI||Large Blend||4||High||11/14/2006||0.50||20.74||15.36||9.51|
|Parnassus Core Equity Investor||PRBLX||Large Blend||4||Above Average||8/31/1992||0.87||16.51||14.61||9.42|
|Parnassus Mid-Cap||PARMX||Mid-Cap Blend||4||High||4/29/2005||0.99||15.96||13.99||9.31|
|Vanguard FTSE Social Index Inv||VFTSX||Large Blend||4||Above Average||5/31/2000||0.22||23.76||17.36||7.92|
Returns through Oct. 31 | Sources: Morningstar Direct; MarketWatch
Domini Impact International Equity (DOMIX) a five-star fund that has a high sustainability rating, is a favorite of Hale's. It has a 1.46% expense ratio, pretty high these days, but not terrible for an international fund that has a good long-term track record and ESG bona fides to boot. It has a value bent, and holds foreign multinationals such as Sanofi (SNY), Allianz (AZSEY), Unilever (UN), and Nissan (NSANY).
If you prefer emerging markets with a spoonful of ESG, Calvert Emerging Markets (CVMYX) may be your cup of tea. Though it's been around for only five years, making it the youngest fund on our list, it's performed impressively during that time and its expense ratio is pretty good for an actively managed emerging-markets fund. The fund's top holdings are heavily concentrated in companies from greater China, which could be a concern for some.
Parnassus, the other long-term player in this market, has three U.S. funds in the top seven: Parnassus Endeavor (PARWX), a large growth fund; large-blend Core Equity Investor (PRBLX), and Mid-Cap (PARMX). All have expense ratios under 1%.
You could also go with the only ETF on the list, iShares MSCI KLD 400 Social ETF (DSI), or the Vanguard FTSE Social Index (VFTSX). They track different indexes, but have similar performance and are the cheap and easy way to do well by doing good.
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