As it turns out, investing for good can be profitable too. That's the story behind the amazing rise in ESG investing over the last several years. Investors are flocking to ESG (environmental, social, and governance) funds in particular, dumping a net $97 billion into ESG ETFs and sparking the launch of some 200 new ESG ETFs in 2020 alone.
Why have ESG funds become so popular? During market contractions in 2018 and 2020, companies with solid ESG track records showed more resilience than their non-ESG peers. Even better, that resilience doesn't come at the expense of performance in the good times. As a broader point of comparison, the S&P 500 ESG index has outperformed the standard S&P 500 index over the last one-year, three-year, and five-year time frames.
Going forward, ESG investors may also get a hand from the federal government with government contracts flowing into clean energy companies. That's because the Biden administration has a major climate change initiative on its list of things to do. All of that means now may be the time to round out your portfolio with more ESG exposure across different asset classes.
1. For large-cap ESG stocks
The Fidelity U.S. Sustainability Index Fund (NASDAQMUTFUND:FITL.X) is a large blend fund, meaning its portfolio focuses on the largest public companies and offers a mix of growth and value stocks.
While all stocks have some volatility, large, U.S.-based companies are usually more stable in price and performance than smaller or international companies. For that reason, a diversified, large blend fund -- ESG or otherwise -- can function well as the core of your equity holdings.
FITL.X tracks the performance of the MSCI USA ESG Index, which includes companies that have high ESG performance relative to peers in their sector. The fund holds 290 positions with a 27% concentration in information technology. You'll recognize all of the top 10 holdings, which include Microsoft, Alphabet, Johnson & Johnson, Tesla, and Proctor & Gamble.
FITL.X has net assets of $644 million and an expense ratio of 0.11%. The fund's average annual returns between 2018 and 2020 were 14.72%, while the benchmark index returned 14.88%, and the overall large-blend category grew 11.89%.
2. For emerging-market ESG stocks
Emerging markets are countries that are investing in industrialization and productive capacity. They tend to grow much faster than developed markets, but they can also be more volatile. Generally, emerging-market economies are less resilient in the face of global economic downturns as well as social or political instability at home.
You could invest a slice of your portfolio in emerging markets to diversify outside the U.S. and for the growth opportunity. But this strategy isn't for the faint of heart. A look at the history of the MSCI Emerging Markets Index shows you why. The index grew more than 18% in 2017, 2019, and 2020, but it dipped more than 14% in 2015 and 2018. How much of those year-to-year swings you can handle is up to you, though many savers will cap their emerging-market exposure to no more than 10% of the portfolio.
Calvert Emerging Markets Equity Fund (NASDAQMUTFUND:CVMI.X) invests in emerging-market companies with good sustainability track records. According to fund documentation, the fund's positions hold 100% lower fossil fuel reserves and have 94% lower carbon emissions vs. the MSCI Emerging Market Index. CVMI.X does have a fairly small portfolio of only 55 stocks, mostly weighted in the information technology and consumer discretionary sectors. Net assets are $4.1 billion, and the fund's net expense ratio is 0.99%. Five-year annual returns are just a shade under 15%.
3. For corporate bonds
If you're young, you might be fully invested in stocks and equity funds. As you age, it's best practice to shift some of your wealth into fixed-income positions to add stability. U.S. Treasury debt is often the go-to choice in that asset class, because it's very low risk. But of course, low risk goes hand-in-hand with low yield. Ten-year Treasury rates have been below 2% since the second half of 2019 and were below 1% for most of 2020.
Corporate bonds are an alternative. They carry more risk than Treasury debt but do pay higher yields. A corporate bond fund also provides another opportunity to support companies with sustainable business practices.
iShares ESG Aware 1-5 Year USD Corporate Bond ETF (NASDAQ:SUSB), for example, holds short-term, investment-grade corporate bonds issued by companies with positive ESG track records. Top issuers include Morgan Stanley, Microsoft, Bank of America, and American Express. The fund has net assets of $549 million and an expense ratio of 0.12%. Its three-year average return is 4.23%.
Your ESG investment portfolio
The ESG story is a compelling one, particularly if sustainability is important to you. But the decision to increase your ESG exposure is still an investment decision that requires the usual level of due diligence. Read fund documentation, understand the investing approach, check the track record of the fund and its manager, and keep an eye on those fees. You want to support companies that are making a positive impact in the world, but you should expect a financial benefit in return.