Exploring ESG Funds: A Key to Resilient and Impactful Investing

Key Takeaways

• ESG funds are portfolios of equities and/or bonds for which environment, social and governance factors have been considered.

• Such funds have demonstrated more resilience in downturns than their non-ESG counterparts and have regularly outperformed the S&P 500.

• ESG ETFs comprise a mix of equities, bonds, and other financial instruments, and are traded on stock exchanges.

Investors are increasingly seeking funds that aim to have a sustainable and lasting societal effect on the world, and they now have more options than ever. Last year, according to the US SIF Foundation, assets under management in ESG and other sustainable strategies in the United States comprised about $8.4 trillion of the $66.6 trillion in overall U.S. assets.

Further, such funds have demonstrated more resilience in downturns than their non-ESG counterparts and have regularly outperformed the S&P 500. But just what are ESG funds, and among those, which are most popular? That and more are covered below. 

What are ESG Funds?

ESG is the acronym for environmental, social, and governance. Thus, ESG funds are portfolios of equities and/or bonds for which ESG factors have been considered. In other words, these funds, which comprise the shares of many companies, are investments that are assessed based on ESG principles. 

Note that rather than individual stocks, funds comprise shares of many companies, which can also serve to mitigate risk.

What are ESG Criteria?

ESG criteria are used to evaluate environmental, social and governance performance, and can vary in their focus. They are factors that are considered in the investment fund process, such as:

Environmental

This generally means how the funds consider conservation and protection of the natural environment. The category covers, for example:

• Natural resources and land use
• Air quality and emissions
• Energy and use and conservation
• Hazardous materials usage
• Water quality and waste management

Social

This portion of ESG has to do with relationships with employees clients, customers, and communities, and generally covers:

• Production quality and safety
• Employee relations and labor standards
• Impact on local community
• Equal employment opportunities
• Education, healthcare, and housing

Governance

This stands for standards for company leadership, shareholder rights, and risk controls. It generally encompasses:

• Voting rights
• Board diversity and independence
• Ethical business practices
• Executive compensation versus employee compensation
• Tax and account transparency
• Encourages diversity

What are Popular ESG Funds?

There are several ESG fund options from which to choose, which can include, but are not limited to:

• Vanguard FTSE Social Index Fund. This relatively new fund tracks the FTSE4Good US Select Index that excludes industries such as adult entertainment, weapons, gambling, and alcohol.
• Fidelity U.S. Sustainability Index Fund. This fund tracks an index that includes companies that have the highest ESG ratings among their sectors.
• Nuveen ESG Mid-Cap Growth ETF. This fund comprises some 60 mid-sized and rapidly growing companies such as Etsy, GoDaddy and Burlington Stores.
• Evercore Equity Fund. While not a dedicated ESG fund, it considers robust governance in security selection.
• Pimco Total Return ESG Fund. This fund is a diversified portfolio comprised primarily of fixed-income securities with a focus on socially conscious companies. 

What are Types of ESG Funds?

There are several types of ESG funds, including:

• ESG exchange traded funds. ESG ETFs comprise a mix of equities, bonds, and other financial instruments, and are traded on stock exchanges. They tend to carry lower fees than mutual funds.
• ESG mutual funds. These funds have stocks and bonds that have predetermined criteria. Here, investors can benefit from diversification and liquidity, in addition to professional management.
• ESG index funds. A type of ESG mutual fund, an ESG index fund passively follows ESG-centric companies that trade on the S&P 500 or other index.

What are the Benefits of Investing in ESG Funds?

There are a number of advantages to investing in ESG funds, including:

• Possible outperformance. In addition to the potential for reduced risk, such funds could offer better performance than traditional funds.
• Environmental conservation. Such investments can potentially help the environment and help solve climate change.
• Protect employee welfare. ESG investors want to see that companies have a reputation for doing right by their employees.
• Building long-term wealth.  Companies that have sustainability plans may be better prepared to meet long-term investment objectives.

How to Choose the Best ESG Fund for Your Portfolio?

There are added considerations when going with ESG funds over more conventional funds, to wit:

• Know the difference between passive and active funds. When choosing one over the other, investors should consider their investment goals, experience, and tax situation.
• Choose area of impact. Investors should seek a fund that is aligned with their goals.
• Consider how an ESG fund would fit in their portfolio. Investors must think of their existing portfolio makeup.
• Understand the fund’s effect. It is recommended that investors insist on a fund impact report. 

How Do ESG Funds Differ from Other Funds?

There are ways in which ESG funds break from other funds. For example, impact investing refers to funds allocated to companies that drive social or environmental change, thereby delivering impact. While ESG takes a broader approach that focuses on shielding a portfolio from reputational or operational risk, SRI investing excludes companies based on certain criteria.

How to Invest in ESG Funds?

To invest in ESG funds, one can select screening parameters and search through a database for the preferred sustainable investments.

One of the easiest ways to get started with ESG investing is to employ a robo-advisor that offers a portfolio that is socially responsible, which usually means ESG-graded exchange-traded funds.

How to Invest Beyond Stocks?

The potential benefits of ESG funds notwithstanding, such funds are often comprised of stocks, which are subject to market swings. 

Another approach could involve alternative investments such as those offered by the leading platform Yieldstreet, which seeks to help investors generate income outside traditional public markets. Previously reserved for institutions and the ultra-rich, alternatives such as real estate and art also serve to diversify portfolios, which is essential to successful investing.

Alternative Investments and Portfolio Diversification

Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings. 

Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk. 

In some cases, this risk can be greater than that of traditional investments.

This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million.  These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform. However, that meant the potentially exceptional gains these investments presented were also limited to these groups.

To democratize these opportunities, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments. 

Learn more about the ways Yieldstreet can help diversify and grow portfolios.

Summary

The growth of ESG funds is reflective of a growing societal insistence that companies with which they do business – and in which they invest – are responsible stewards of the environment, solid corporate citizens, and are guided by accountable managers and executives. They are also proliferating because their generally positive performance.

It is important to keep in mind, though, that funds comprise securities that are directly correlated with volatile public markets. There are, though, potential “alternative” investments that are not. Such investments can prospectively provide steady secondary income while diversifying portfolios to mitigate overall risk.