Invest Your Savings with Socially Responsible Funds

How to identify and evaluate ESG funds

Liz Baker
Jun 17 · 6 min read

Now that you have a bit of money to invest, you know you need to put it in the stock market to get the needed compounded growth to meet your financial goals. But the last thing you want is for that money to support the bottom of line of companies that do not share your values.

Exxon Mobil (XOM)? Altria (MO)? Oh, heck no.

You plan to invest in a mutual fund (or ETF) which will invest in hundreds of different companies. How can you tell?

For a while now, there has been a push to invest in companies that follow ESG principles. ESG stands for Environmental, Social, and Governance.

  • Environmental criteria include energy use, carbon emissions, pollution, and treatment of animals
  • Social criteria include the health and safety of employees and customers, diversity, and support of local communities. Also, the ESG practices of suppliers and other business partners are also considered.
  • Governance criteria include transparent accounting, avoidance of conflict of interest, a diverse board, and fair executive compensation. Obviously, any corruption, bribery, and even political lobbying are big no-nos.

As such, many funds have been advertising themselves as supporting socially responsible investing. However, many of these funds are “self-reported”. Are they truly practicing what they preach, or is it all a marketing strategy? Likewise, are there consistent standards that each is following?

Enter Morningstar. You may already be aware of their “star” rating system. All funds are given a star rating of 1 (bad) to 5 (excellent) based on the fund’s historical price performance.

In 2016, Morningstar added a new sustainability rating, which others have been calling the “globe” rating. They obtain their data from Sustainalytics who specialize in ESG solutions.

Those funds scoring in the highest 10% get a five “globe” rating; those in the next 22.5% get a four “globe” rating. And so on.

How do the Indexers fare? Index funds (and ETFs) of the S&P500 get a solid “average” of 3 globes.

Vanguard 500 Index Investor Fund. Available at: https://www.morningstar.com/funds/xnas/vfinx/quote.html

ESG Performance?

The big question is whether ESG investing is as profitable as regular investing. A recent study by Chang, et al. (2019) addressed this question by comparing funds with a low globe Morningstar rating (bottom half of the list) to funds with a high globe rating (top half of the list). The performance was compared using the Morningstar “star” rating. Their data set included equity (stock) funds, fixed income (bond) funds, and balanced funds (both).

Good news! They found no statistically significant difference in performance between the high globe-rated funds and the low globe-rated funds.

Will investing in an ESG fund cost more, thus cutting into your returns? The authors further divided the funds into low-cost and high-cost funds. In general, low-cost funds, regardless of globe-level, performed better than high-cost funds. (Yet another argument against high-cost funds. You are NOT getting what you paid for.)

More good news! Among the high-globe group, the performance of low expense funds was uniformly better than the performance of high expense funds. Or looking at it a different way, in the low-cost group, there was no difference in performance between the high-globe and low-globe groups.

(However, that may not be quite the case with “index”-like funds. See below. . .)

Even more good news! 80% of the funds that “self-reported” themselves as ESG funds, did indeed have a high globe rating. So, investors can be relatively confident in investing in these funds.

A Better ESG “Index” Fund?

My favorite S&P500 index fund gets a piddly 3 globes. Can I replace my index fund with a similar ESG fund? Let’s run a screen of Large Blend, US equity funds, with 5 stars, no-load, and expenses ≤ 0.50%.

Out of the forty funds the screen identified, those with a globe rating of either four or five are listed below. The “classic”, Vanguard 500 Index (VFINX) is included for comparison.

Big Fat Disclaimer: the funds listed are simply ideas, not recommendations to invest. This is not an implied endorsement of mutual fund companies or their products (although I do have my favorites. . .) I am neither affiliated with, nor invested in, any of the funds listed. Investing involves risk; past performance does not indicate future performance.

Values reported as of June 2019. VFINX is included for comparison. Some funds have multiple “versions” which are listed together along with the range of values reported. All information is from Morningstar.com. SD = standard deviation.

Standard deviation (SD) is a measurement of variability or risk, both up and down. The higher the SD, the more money you’ll make in an up market; likewise, the more money you’ll lose in a down market. Most of the listed funds have an SD like that of the S&P500 index.

The Sharpe score is the fund’s return, minus the risk-free rate of Treasuries (usually 1–3%), divided by the standard deviation. It is a measure of return per unit of risk. A higher score is better.

Alpha is return in addition to what you’d expect, given the risk taken. Again, higher is better. As the S&P500 effectively equals the market, index funds have an alpha of close to zero, which is fine.

As our goal was to find a fund like the S&P500 index, most of these measurements were only included to see if the fund deviated much from the S&P500.

The key value is the expense ratio. Index funds are notorious for ridiculously low expense ratios. The fund manager doesn’t have a lot to do if their job is to simply match an index.

Except for Vanguard’s FTSE Social Index fund, all funds have an expense ratio higher than our comparator S&P500 fund, VFINX. In some cases, a slightly higher return and alpha may make up for that. Otherwise, you may need to pay a slight premium for ESG.

Of the funds listed, only two have a five-globe rating. (Oddly, neither fund has a “mandate” to be an ESG fund.) GMO Quality has three, almost identical, funds which have been listed together. Not surprisingly, GMO itself is committed to ESG investing. These funds have the highest return and alpha listed, which should more than compensate for the slightly higher expense ratios.

Vanguard PRIMECAP also has a five-globe rating. However, it has a slightly higher expense ratio than the comparator, that is not offset by a better Sharpe score or alpha. But it has a slightly higher return, most likely due to slightly higher risk (SD).

If the expense ratio is a concern, the cheaper Vanguard FTSE Social Index has a slightly better return and alpha than the index fund FVINX, but with a four-globe rating.

So, yes, it is possible to invest responsibly. In most cases, you won’t need to sacrifice performance. Although you may not be able to match the ridiculously low expense ratio of the typical index fund, expenses are otherwise very reasonable.

Do you have a favorite ESG fund, with a low expense ratio? Let me know in the comments below.


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This information has been provided for educational purposes only and should not be considered financial advice. Any opinions expressed are my own and may not be appropriate in all cases. All efforts have been made to provide accurate information; however, mistakes happen, and laws change; information may not be accurate at the time you read this. Please seek out a licensed professional for current advice specific to your situation.

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Liz Baker

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Liz Baker

Scientist nerd, and champion of medicine, personal finance, and innovation. Using knowledge to empower others to succeed in life. Or simply enjoy kittens.

Making of a Millionaire

Publishing Stories on all things related to personal finance