As it turns out, investing for the greater good can be profitable, too. That's the story behind the rise in environmental, social, and corporate governance (ESG) investing over the past several years. Investors are flocking to ESG investing by way of ESG-focused funds. Annually, net inflows to sustainability-focused funds from investors around the world have reached billions of dollars.
What are ESG funds?
ESG funds invest in companies that actively manage their environmental, social, and governance risks. These companies commonly pursue a range of sustainability goals, such as:
- Improving energy efficiency.
- Reducing emissions.
- Forming social advancement opportunities within their communities and workforces.
- Preventing human rights violations throughout their supply chains.
- Enforcing ethical business practices.
- Creating board independence and reporting transparency.
In short, companies that prioritize ESG are good corporate citizens. They dedicate significant resources to improving their impact on people, communities, and the environment.
In other respects, ESG funds function like any other investment fund. When you buy shares in an ESG fund, you own a slice of the fund's holdings and participate in the fund's performance. They can be mutual funds or exchange-traded funds (ETFs).
Exchange-Traded Fund (ETF)
Nine best ESG funds to add to your portfolio
ESG funds can vary widely in the assets they hold. Some may suit your values and investment needs better than others. Be sure to review each prospective fund's investing approach carefully, starting with the nine top ESG funds highlighted below.
Fund Name and Ticker | Year Launched | Net Expense Ratio |
|---|---|---|
iShares ESG Aware MSCI USA ETF (NASDAQ:ESGU) | 2016 | 0.15% |
iShares ESG Aware MSCI EM ETF (NASDAQ:ESGE) | 2016 | 0.26% |
iShares ESG Aware U.S. Aggregate Bond ETF (NYSEMKT:EAGG) | 2018 | 0.10% |
SPDR S&P 500 ESG ETF (NYSEMKT:EFIV) | 2020 | 0.10% |
Nuveen ESG Small-Cap ETF (NYSEMKT:NUSC) | 2016 | 0.31% |
iShares ESG Aware 1-5 Year USD Corporate Bond ETF (NASDAQ:SUSB) | 2017 | 0.12% |
Nuveen ESG Mid-Cap Growth ETF (NYSEMKT:NUMG) | 2016 | 0.31% |
Invesco ESG NASDAQ 100 (NASDAQ:QQMG) | 2021 | 0.20% |
iShares ESG Aware Moderate Allocation ETF (NYSEMKT:EAOM) | 2020 | 0.18% |
1. iShares ESG Aware MSCI USA ETF
NASDAQ: ESGU
Key Data Points
iShares ESG Aware MSCI USA ETF (ESGU -0.17%) tracks the MSCI USA Extended ESG Focus Index. The index mimics the performance of the broader market while excluding companies involved in civilian firearms, controversial weapons, tobacco, thermal coal, and oil sands. Top holdings by value include Nvidia (NVDA +1.68%), Apple (AAPL -0.20%), and Microsoft (MSFT +1.37%).
This ETF is appropriate as an anchor position for new ESG investors who want to invest in sustainability without materially altering their risk profiles. As long as the fund meets its goal, its performance should be near that of an S&P 500 fund.
2. iShares ESG Aware MSCI EM ETF
NASDAQ: ESGE
Key Data Points
iShares ESG Aware MSCI EM ETF (ESGE +0.16%) provides ESG-screened exposure to emerging markets. The fund aims to produce returns similar to unscreened emerging market indexes while prioritizing companies with higher ESG scores. The portfolio includes more than 300 large-cap and mid-cap stocks, primarily from China, Taiwan, India, South Korea, Brazil, South Africa, and Saudi Arabia.
Financial companies comprise roughly one-quarter of the fund's value, and information technology stocks are a close second. The other top three sectors are consumer discretionary, communications, and materials.
3. iShares ESG Aware U.S. Aggregate Bond ETF
NYSEMKT: EAGG
Key Data Points
4. SPDR S&P 500 ESG ETF
NYSEMKT: EFIV
Key Data Points
SPDR S&P 500 ESG ETF (EFIV +0.06%) tracks the S&P 500 ESG Index, which often outperforms the traditional S&P 500. The index excludes S&P 500 companies involved in cluster weapons, landmines, chemical weapons, nuclear weapons, tobacco, or thermal coal extraction.
Also excluded are companies that Sustainalytics has classified as noncompliant with United Nations Global Compact principles. The principles are U.N.-defined business standards covering human rights, employee rights, the environment, and anti-corruption.
This fund's top three holdings by value are Apple, Nvidia, and Microsoft. The SPDR fund weights these positions slightly higher than the iShares ESG Aware MSCI USA ETF.
5. Nuveen ESG Small-Cap ETF
NYSEMKT: NUSC
Key Data Points
6. iShares ESG Aware 1-5 Year USD Corporate Bond ETF
NASDAQ: SUSB
Key Data Points
NYSEMKT: NUMG
Key Data Points
NASDAQ: QQMG
Key Data Points
Invesco ESG NASDAQ 100 (QQMG +0.08%) is the ESG version of the popular Invesco QQQ ETF (QQQ -0.02%). The fund identifies suitable stocks from the Nasdaq-100 by screening out those participating in unsavory activities, such as tobacco and gambling. It also excludes companies that don't comply with the United Nations Global Compact principles.
The portfolio contains roughly 90 large-cap, Nasdaq-listed stocks, with Nvidia, Microsoft, and Apple at the top of the list.
9. iShares ESG Aware Moderate Allocation ETF
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Benefits and risks of ESG funds
ESG funds can offer investors an opportunity to align their portfolios with their values while actively seeking long-term financial returns. Here are some benefits to consider if you want to put cash into an ESG fund:
- Enhanced risk management: By evaluating a company's ESG practices, funds can identify potential risks that traditional financial analysis might miss. This can offer a more reliable investment vehicle for long-term shareholders.
- Potential for long-term returns: Companies with strong ESG practices are often better managed and more resilient, which can lead to stable, long-term performance. During times of market turbulence, some ESG funds have also shown more resilience than conventional funds. Of course, it comes down to the types of companies contained in the fund you’re looking at.
- Alignment with personal values: ESG funds allow investors to support businesses that prioritize sustainability, ethical labor, and good governance, and are making a positive impact on society and the environment.
- Improved investor confidence and demand: Companies with robust ESG practices tend to be more transparent, which can boost investor confidence. Growing demand from investors can increasingly drive capital into companies with strong ESG credentials in the years ahead.
However, like any investment, these funds also come with some risks that investors should consider before allocating capital.
- Lack of standardized metrics and transparency: A key challenge is the absence of universal, standardized metrics for ESG performance. Different rating agencies use various proprietary methodologies, which can be confusing and lead to inconsistent ratings for the same company.
- Greenwashing: The ambiguity of ESG criteria opens the door to greenwashing, where a fund or company misrepresents or overstates its commitment to ESG. Misleading marketing can deceive investors into believing an investment is more sustainable than it actually is, and erode the integrity of an ESG investment.
- Higher costs and due diligence: ESG funds often come with higher fees than traditional funds due to the increased due diligence required to analyze non-financial factors. This also requires investors to perform their own research to look beyond fund labels.
- Limited investment universe: By excluding certain sectors like oil and gas, ESG funds can narrow the range of potential investments. While this aligns with some investors' values, it can increase portfolio risk by creating a concentration in specific industries.
How to choose the best ESG funds
Start by prioritizing the ESG issues that are most important to you. ESG is a broad category, so start by identifying issues that are most important to you. For example, you may find an ESG fund that prioritizes reducing carbon emissions or that invests in companies with a commitment to diversity and human rights policies.
Make sure you understand the fund's ESG strategy. A fund's prospectus will detail its specific approach to applying ESG principles. Here are a few popular ESG strategies that many funds deploy:
- Exclusionary screening: Also known as negative screening, this strategy excludes companies based on specific activities, such as weapons manufacturing, tobacco, or fossil fuels.
- Positive screening: This approach proactively invests in companies that demonstrate strong ESG performance relative to their industry peers.
- ESG integration: Many fund managers incorporate ESG risks and opportunities into their traditional financial analysis. The goal is often long-term financial performance rather than a direct social or environmental impact.
- Impact investing: This strategy targets investments that aim for a specific, measurable social or environmental impact alongside financial returns, such as funding a renewable energy project.
- Thematic investing: These funds concentrate on a specific ESG theme, such as clean water, gender diversity, or renewable energy.
Don't rely solely on the fund's name or ESG rating. Read the fund's prospectus to review the list of companies it holds. This is the most direct way to ensure that your investments align with your personal values.
You’ll also want to consider whether to invest in a passive or actively managed ESG fund. Passive funds are often low-cost index funds that track a specific ESG benchmark. They offer transparency and lower fees, but may be limited by the index's rules and can't adapt to rapidly changing market conditions.
On the other hand, active funds are managed by professionals who select investments based on their own analysis. However, they have higher fees and often underperform their passive counterparts over time.
Exclusive ESG Fund Q&A with Professor Katherine Klein
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