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What’s an ESG mutual fund? Here’s how to invest in equitable and sustainable companies

<i>Marcus Brandt/picture alliance/Getty Images</i><br/>Wind turbines stand next to a hall with photovoltaic systems on the roof in Schleswig-Holstein
dpa/picture alliance via Getty I
Marcus Brandt/picture alliance/Getty Images
Wind turbines stand next to a hall with photovoltaic systems on the roof in Schleswig-Holstein

By Jeanne Sahadi, CNN Business

Climate change. Inequality. Unrest. There’s a lot to consider in today’s world and you may find yourself wanting to invest only in companies that aim to do business in an environmentally sustainable, socially equitable and ethical way.

Or, maybe you just want to invest in companies that are taking steps to protect their bottom line from the very real business risks posed by climate change or social inequities.

Either way, you’re probably not eager to lose money. So you’d like to make investments that deliver a competitive return over time.

That’s a balance so-called ESG mutual funds are trying to strike.

The ESG acronym stands for environmental, social and governance issues — all of which face public companies and their stakeholders, which include investors, customers, employees and the communities where a business operates.

Thanks to growing demand, there are far more ESG funds today than a decade ago. A recent survey — by JUST Capital and partner organizations — found that “Americans overwhelmingly support public disclosure on human capital and environmental impact metrics from America’s largest companies, and endorse federal action to require standardized disclosure.”

Here’s what you need to know before investing:

What constitutes an ESG fund?

Rather than sort through individual companies’ commitments to ESG goals, most investors will outsource that task to an ESG mutual fund.

But ESG funds can differ in ways big and small. And not all of them will align with your biggest environmental, societal or governance concerns.

“ESG means so many different things to so many different people,” said Alyssa Stankiewicz, a sustainability analyst with Morningstar Research Services LLC.

So before investing in an ESG fund, at the very least read the principle investing strategy page in the fund’s prospectus to see what the investing priorities are, Stankiewicz recommends.

Know, too, there is no single set of ESG metrics against which every fund manager assesses a company — or which companies use to assess themselves when making ESG promises.

Also, managers will not necessarily give equal weight to all three components of ESG when deciding what to include in their portfolios.

Environmental concerns are likely to be given more weight than social concerns. There are more widely agreed upon metrics and better availability of data on environmental concerns than on social ones, Stankiewicz said. “I think this has to do with different markets, cultures, and regulatory environments.”

She further noted that of all the potential social issues, diversity on boards is probably the most widely accepted metric, but even then, what defines diversity and what the goals are can vary by market.

On March 21, the Securities and Exchange Commission is expected to propose rules that would standardize climate change disclosures for US companies and establish liabilities for those that fail to meet their climate change pledges.

“We expect additional ESG proposals in the coming years that will tackle social justice and governance as well as asset managers who make ESG claims,” said Jaret Seiberg, a managing director at Cowen Washington Research Group, in a client note. “The idea is that standardized disclosure would benefit investors by letting them compare performance among public companies.”

Performance can be competitive

Just because a fund’s portfolio considers environmental, societal and governance concerns, does not mean investors have to sacrifice profit.

“Most ESG funds are looking at data from the perspective of mitigating the impact of environmental and social risk to a company’s bottom line,” Stankiewicz said.

In fact, many ESG funds have shown they can deliver competitive returns, with just over 50% finishing in the top half of their peer groups last year, according to Morningstar.

Ranking ESG funds from best to worst depends on what your most important metrics are. But to be a top ESG fund by Morningstar’s standard means ESG concerns play a central role in the fund’s strategy and the fund manager’s decisions. In other words, ESG is not merely a marketing tagline to which only lip service is paid. And it means the prospectus is explicit about what the fund’s ESG objectives are.

Secondly, Morningstar also considers performance and a fund’s potential to outperform in their categories — such as large cap blend or taxable bonds, etc.

Its latest list identifies 17 funds that are distinguished for their ESG commitment levels. Of those,12 delivered returns in the top half of their peer group last year. And four of them were standouts for their ESG commitment at both the strategy and manager levels: Parnassus Core Equity (PRBLX), Calvert Equity (CSIEX), Pax Global Opportunities (POGOX) and TIAA-CREF Core Impact Bond (TSBIX).

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