Are you among the millions who want to ensure you are investing your hard-earned money in companies building a sustainable future? Environmental, social, and governance (ESG) conscious investments denote a standard of examining the underlying companies to ensure their corporate policies align with these hot topic issues.
Because there are no commonly agreed upon or universal ESG standards, not all ESG funds are created equal. Like most megatrends, financial institutions and investment management companies have jumped on board to brand their index funds with an ESG insignia.
However many individuals are surprised to learn that the ESG funds they invest in allocate part of their portfolios into names such as ExxonMobil or Chevron. This disparity with an investor’s expectation can occur because a fund manager or index provider exercises discretion on ESG criteria guidelines.
If your investment goals include diversifying in sustainable companies, then ESG funds can be an intelligent choice for your situation. But all funds are not created equal, so we will examine critical factors to help you make investment decisions that align best with your personal goals and values.
Read on if you need clarification on ESG funds or which funds you should invest in. We’ll break down everything you need to know about an ESG fund and how it works and provide a list of the best ESG funds and why we like them. Get ready to become fluent and knowledgeable in ESG funds.
What Are ESG Mutual Funds and ETFs?
Stock funds are investment vehicles comprised of multiple stocks from various companies listed on the stock market. You can purchase shares in an exchange-traded fund (ETF) or mutual fund, which equates to partially acquiring ownership in multiple companies simultaneously, diversifying your portfolio automatically and protecting yourself from a single company’s unfavorable stock move.
For example, suppose you invest $10 in a fund that owns shares in Companies A, B, C, and D. In that case, even if Company A doesn’t do well, your fund shares will only go down based on the percentage of the fund that was invested in Company A, the and overall fund holdings are still valuable.
Have you ever wondered what ESG stands for?
An ESG fund is an investment option primarily evaluated by the three metrics – environmental, social, and governance considerations. Each business included in an ESG fund is considered against several factors:
Environmental criteria consider how well a company aims to minimize its carbon footprint and climate change. Even companies such as factories, oil producers, and airlines, whose companies damage the environment, can still be considered positive environmental investments if they significantly reduce their practices or offset their carbon emissions.
For example, Exxon Mobile invests heavily in carbon capture projects, which is often a key criterion for inclusion into popular ESG ETFs and mutual funds.
Social criteria include examining the company’s relationships within the economic ecosystem they impact. Specific relationships include clients, employees, advertisers, suppliers, partners, communities, and local governments. Other factors also regard the well-being and support of their partners through volunteer work, support systems, charitable donations, social justice, diversity, and anti-discrimination.
Governance investing focuses on management, leadership, stockholders, audits, risk management, and internal control issues. The most important criteria often include holding management and executives accountable for their actions. Furthermore, companies should not appoint unethical board members or make political contributions to sway governmental policy.
What Do ESG Funds Invest In?
Think of ESG funds are funds comprised of companies that adhere to environmental, social, and governing principles and responsibilities. When you invest in an ESG fund, you’re investing in several companies that address these pressing issues.
Many investors like to invest in Environmental, Social, and Governance funds because their investment money will hypothetically go toward companies they morally or philosophically believe in. Through ESG funds, you can invest only in companies, for example, that are working toward making positive impacts, such as carbon neutrality or workplace diversity, and not only focused on profitability.
In many ways, ESG investing within ETFs allows you to invest wisely and responsibly while protecting your portfolio. It’s the best way to practice sustainable investing with the help of ESG fund managers (at least in the case of actively managed funds or indices).
ESG Factors to Consider When Choosing a Fund
ESG funds come in several varieties, and common terms include impact investing, sustainable investing, socially responsible investing, or simply responsible investing. Generally, all of these terms cover the landscape of ESG companies and funds.
Socially responsible investing (SRI) usually focuses primarily on companies meeting socially ethical criteria such as inclusion, diversity, and anti-discrimination against sex, gender, race, or ethnic groups. SRI funds often lack a direct focus on investing based on environmental criteria.
While investing in any ESG funds can be beneficial, there are better and worse ESG funds for you to invest your cash. So let’s take a look at some key factors you should consider before investing in any fund, ESG or otherwise.
ETF or Mutual Fund?
First, determine whether the ESG index fund is an exchange-traded or mutual fund. ETFs or mutual funds may be actively or passively managed portfolios. However, even passively managed funds may track an ‘active index’ that requires more implicit costs from regular rebalances or changes to portfolio holdings.
Exchange-traded funds are usually passively managed groups of stocks and track an external index. That means they typically offer cheaper costs and have no minimum investment thresholds – eliminating the barrier to entry for new investors. ETFs are also quite tax efficient. You can even invest in ETFs with as little as one dollar, as many brokers currently offer fractional share investments. Exchange-traded funds usually have lower explicit fees since they don’t usually employ active stock managers who constantly research, trade, and observe the fund’s holdings and positions.
Mutual funds may also be either actively or passively managed, depending on the specific mutual fund. In either case, they are overseen by professional portfolio managers, similar to ETFs. These market experts closely watch stock activity, and many regularly add or remove stocks to the fund’s holdings. Mutual funds have historically been actively managed funds, but with the investment management world trending toward passive index investing and lower fees, there have been more passive mutual funds gaining popularity in recent years.
Mutual funds usually have higher financial barriers to entry, and they may charge extra load fees for you to retain holdings in them. In addition, keep in mind that you can only buy and sell mutual fund shares once per day at the stock market’s closing price. Actively managed ESG mutual funds tend to focus more heavily on sustainability or socially responsible investing (SRI), and fund managers need to keep a close eye on evolving social trends and issues.
Regardless if you’re new to investing or a seasoned veteran, an ESG ETF is likely the best choice due to lower costs.
Technically any ESG index fund will target socially responsible companies in their portfolios, but fund objectives and inclusion criteria might not be ideal for your specific investment objectives and include potential environmental issues or governance factors.
How Do You Want Your Money to Impact the World?
It would help to consider how you want your money to impact the world. Investing in an ESG fund aims to put your money into companies that operate responsibly and ethically based on your values.
But you can choose ESG funds and companies based on how they focus their efforts. Most ESG criteria has barred investing in firearms and tobacco industries, but there is more disparity among gambling, alcohol, energy, military, and defense sectors. For example, suppose you are a woman and only want to invest in companies that strive toward gender equality and reducing the gender pay gap. In that case, you can research different funds and find female-owned companies, funds that prioritize gender equality, etc.
Similarly, if greenhouse gas emissions and climate change are big issues for you, invest in ESG funds prioritizing carbon neutrality, minimizing greenhouse gas emissions, and carbon capture. Our research will clarify which ESG funds include energy companies that function in the oil, gas, or coal-producing sectors, which may be unacceptable for some investors.
Ask for an Impact Report
Lastly, if you are unsure, you can always ask for an impact report from each ESG fund you plan to invest in. An impact report is a detailed breakdown of where your investment money goes and how the companies in a given mutual fund or ETF operate.
Think of an impact report as a deep dive into a fund’s real impact or costs. Any good ESG fund manager should provide you with an impact report when you ask – if they can’t provide you with a detailed impact report, it’s a bad sign and an indicator that you should look for a different fund in which to invest.
Best ESG Funds to Invest In
Now that you know what ESG funds are and why they are important, let’s break down our top ESG funds in detail. Each of these funds could be a particularly worthwhile investment, but it’s up to you to determine where you want to put your money.
1. Vanguard FTSE USA All Cap Index ETF (ESGV)
The Vanguard FTSE USA All Cap Index exchange-traded fund (ETF) is our top pick for an all-around ESG ETF. The Financial Times Stock Exchange Group (FTSE) index is very comprehensive and includes about 1500 different companies. All businesses in this ETF are U.S.-listed companies spanning large-cap, mid-cap, and small-cap market sizes.
Vanguard’s ESGV ETF boasts an annual industry-low management fee of just .09%. Furthermore, the fund is actively traded and highly liquid, eliminating any concerns about implicit trading costs, which are more concerning for several less liquid ESG ETFs.
Dissimilar to several other ESG funds, the FTSE USA All Cap Index does not allow most names related to the oil and gas industries. Many funds waver on including energy names that are making an effort to invest in slowing climate change; however, ESGV does not include controversial big oil names, nor does it hold companies related to aerospace or defense.
2. Fidelity U.S. Sustainability Index Fund (FITLX)
Our top mutual fund is the Fidelity US Sustainability Index Fund (FITLX), a passive index mutual fund tracking the MSCI USA ESG Leaders Index. That index includes about 300 companies with very high ESG ratings in their sectors. You can rest assured that no “negative” companies will be in this fund, as any companies heavily involved in gambling, weapons, alcohol, tobacco, and civilian firearms are automatically ineligible for inclusion.
Fidelity U.S. Sustainability Index does include a few oil service industry companies, including Schlumberger and Halliburton. These companies provide auxiliary services for the oil and gas exploration and development sectors, but they are included in various ESG indices. Overall the MSCI USA ESG Leaders Index is a reasonably strict ESG index, and the inclusion of these ‘fringe’ energy companies does not offend us.
Like many broad U.S. market funds, technology stocks are over-represented in the fund and comprise about a quarter of the fund’s holdings. There are also significant stocks in the healthcare, communication, and financial industries, so it may be a good choice if you are looking for portfolio diversification in growing industries above all else (while avoiding investing in bad companies). Microsoft, Alphabet, and Tesla make up some of the top positions in this fund.
3. Vanguard FTSE Social Index Fund Admiral (VFTAX)
The Vanguard FTSE Social Index mutual fund is a low-cost, passive index ESG fund that manages over $3 billion worth of assets. Vanguards flagship ESG mutual fund tracks the FTSE 4 Good U.S. Select Index, comprising approximately 500 individual companies.
Popular holdings in this fund include but are not limited to Microsoft, Apple, and Amazon. Investors enjoy about 1.2% yearly dividends, aligning with similarly composed ESG funds.
Note that Vanguard maintains various “share classes” for their mutual funds. The VFTAX fund refers to the Admiral Class of Vanguard’s mutual funds, which is most typical of individual investors. Larger family offices, wealthy individuals, or institutions may be eligible for lower fees offered at the Institutional Class, VFTNX. Other than requirements of minimum investment size and different fee tiers, the two fund classes comprise identical compositions of holdings.
4. Xtrackers S&P 500 ESG Index ETF (SNPE)
The Xtrackers S&P 500 ESG Index ETF is another smart passive index ETF option. SNPE tracks the Standard & Poors (S&P) 500 ESG index, which is very similar to their flagship S&P 500 index, with several industries and companies removed. The result is a large-cap index with approximately 300 companies and a similar composition to the S&P 500.
Dissimilar to several other ESG indexes, the S&P 500 ESG Index includes oil and gas companies. So long as the companies meet their somewhat arbitrary criteria, S&P keeps certain energy companies in the index and, thereby, in SNPE.
In fact, one of the largest holdings in Xtracker’s SNPE ETF is ExxonMobil, but curiously enough, Chevron is absent in the fund. The ETF also includes well-known energy names such as Conoco Philips and Halliburton.
The S&P 500 ESG Index also breaks from other competing indexes and funds by including several alcohol-related companies in their holdings. Most notably, alcohol names such as Molson Coors, Brown-Forman, and Constellation Brands appear in the index; the alcohol sector is still debated within the ESG world.
5. SPDR S&P 500 ESG Index ETF (EFIV)
State Street Global Advisor’s ESG ETF, EFIV, follows the same index as the previously mentioned fund, SNPE. It would be unfair not to include this fund as it’s almost identical to SNPE in fund holding and composition and even mirrors the annual management fee of 0.10%.
Xtrackers SNPE is more liquid than SPDR’s EFIV, and we estimate the spread difference in the lack of liquidity to add an implicit trading cost of about 0.03% more on average if purchasing EFIV. Therefore we decided to give a slight advantage to SNPE over EFIV.
6. iShares MSCI USA Extended ESG Focus Index ETF (ESGU)
Blackrock’s iShares brand is no stranger to passive index ETFs, as they are the largest ETF provider but not the leader in ESG funds, as ranked by our metrics.
The passive index ETF tracks the MSCI USA Extended ESG Focus Index, which has several nuances within the ESG world. The index includes about 300 names, including energy names such as Chevron and Exxon. This fund also includes companies that provide military and defense products and services, such as Raytheon, Honeywell, and General Electric.
Notable absences in this large-cap fund include Boeing, Lockheed Martin, Constellation Brands, and Brown-Forman.
7. iShares S&P Global Clean Energy Index ETF (ICLN)
iShare’s IGLN ETF includes about 100 holdings focusing on U.S. and international clean energy companies. This fund is primarily an environmental-focused impact fund, mainly focusing on mid-cap-sized companies.
Typical holdings include clean energy, industrial, technology, and utility stocks. The largest holding in the fund is First Solar.
Clean energy ETFs have higher annual management fees, and ICLN is expensive at 0.40% annually.
8. Parnassus Core Equity Fund (PRBLX)
Parnassus is a less well-known asset manager who proclaims they have integrated environmental, social, and governance factors into their investment process since 1984.
The Parnassus Core Equity Fund manages over $23 billion of assets through this actively managed mutual fund, the highest-regarded active fund on our list. It only accepts new companies with serious social responsibility and environmental sustainability commitments. It also excludes companies that are even tangentially connected with unethical business practices.
Notably, the Parnassus fund saw a market performance of about 2.5% better than most S&P 500 funds over the last three years. As a result, not only is this one of the most environmentally and morally responsible funds to invest in. It’s also a top choice if you are looking to invest in an actively managed stock-picking fund.
9. iShares MSCI Emerging Markets ETF (ESGE)
iShares’s ESGE ETF includes approximately 300 companies focusing on emerging markets and most heavily invested in China, Korea, Taiwan, and India. Top holdings include international juggernauts such as Alibaba, Tencent, Samsung, and Taiwan Semiconductor.
This fund is distinct in that its holdings are based outside the U.S. in more emerging economies. Although many of the top holdings are large-cap companies, expect increased volatility due to the geographic instabilities of the companies’ regulators.
10. Nuveen ESG Mid-Cap Value ETF (NUMV)
Nuveen’s mid-cap value ETF, NUMV, boasts about 100 names and passively tracks the TIAA ESG USA Mid-Cap Value Index. The management fee on this ETF is a modest 0.30% annual fee and the fund targets less volatile value companies within the U.S. market.
Nuveen’s ETF offers a distinctly diverse group of holdings compared to ESG competitors, with top sectors comprised of real estate, financials, industrial, and utility companies. Whereas some ESG indexes tend to cut more value holdings in mature industries, NUMV targets these businesses with lower volatility, making it an interesting addition for investors worried about losing exposure to value companies.
11. iShares MSCI USA Select Social Index ETF (SUSA)
iShare’s SUSA ETF includes 175 companies focusing on the major U.S. market but more concentrated among fewer names. The MSCI USA Select Social Index focuses on a mix of exposure to large-cap and mid-cap ESG companies.
Top holdings include big technology names such as Microsoft, Apple, Nvidia, Coca-Cola, and Tesla. Some energy-related companies, such as Halliburton, are included in the fund, but most large energy and alcohol companies are nonexistent from this iShares’s ETF.
12. First Trust ISE Global Wind Energy Index Fund (FAN)
FAN is an ESG ETF fund managed by First Trust. This ETF focuses on tracking the Clean Edge Global Wind Energy Index, exposing your portfolio to support companies that focus on developing and providing renewable wind energy to consumers.
With an annual fee of 0.60% to the fund managers and only mediocre liquidity, the fund is far from a top recommendation on our list. However, this ETF is the leading option available if you are focused on investing specifically in the renewable wind energy space.
This ETF fund was created in 2008 and now has over $500 million in assets under its managers’ oversight. There are plenty of quality holdings included in this fund, like North and Power, Vestas Wind Systems, and Siemens Gamesa Renewable Energy: all power generation or wind power plants and manufacturing companies.
13. First Trust NASDAQ Clean Edge Smart Grid Infrastructure Index Fund (GRID)
The First Trust NASDAQ Clean Edge Smart Grid Infrastructure Index Fund or GRID is an ESG ETF issued by First Trust, similar to FAN. However, this fund emphasizes renewable electrical energy use. It funds companies operating within and innovating within the electrical industry, such as companies that create new electric grid technology and energy storage devices, like solar batteries.
The fund was issued in 2009 and now has assets worth over $2 million. Investors can enjoy annual dividends clocking in at about 0.64%.
Like some of the deficiencies in FAN, GRID has a high annual management fee of 0.70% and is also not highly liquid. Therefore, this ETF is only recommended for long-term investors looking specifically for diversified exposure in renewable electricity companies.
14. Vert Global Sustainable Real Estate Fund (VGSRX)
The Vert Global Sustainable Real Estate Fund is a different ESG fund, which is actively managed and focuses on real estate investment trusts (REITs) or other companies the fund advisor considers sustainable. The fund currently holds about 150 names but is subject to change, as with any actively managed fund.
It only chooses companies that take measures to reduce the real estate sector’s carbon footprints and contribute positively to the environment. Presently, VGSRX owns several investment trusts and REITs, including prominent real estate holdings like Equinix and Simon Property Group.
15. Shelton Green Alpha Fund (NEXTX)
The NEXTX active mutual fund is a reasonable choice for any long-term growth-oriented investor. That’s because it only includes companies that are checked for positive environmental influences and asset appreciation; as a result, the majority of holdings are from well-known companies that have already received accolades for sustainability, like Tesla and IBM. Other top holdings include First Solar, Vestas Wind Systems, IMB, and Deere & Co.
The NEXTX mutual fund also thoroughly analyzes global and market fluctuations and circumstances to minimize risk for all investors. If there’s ever a market shake-up, you can rest assured that the NEXTX fund will keep your portfolio relatively stable.
Our biggest complaint with this ESG fund is its high initial expense of 1.4%, which is frankly too high compared to comparable ESG funds. However, if you are looking for an actively managed fund and believe the performance is justified, NEXTX is a reasonable active mutual fund.
Benefits of ESG Investing (Pros of ESG)
By investing in ESG funds, you are putting your money in companies that are gaining societal trends and political support. Although competiting political parties, social trends, and opposing viewpoints are divided on specific ESG standards, cognizant companies will generally mitigate adverse risk and avoid moving in a manner damaging to future economic opportunities and progress.
For example, investing in a company trying to mitigate its carbon footprint will not add significant risk to its business model. However, investing in coal or transportation companies may have additional risks as older technologies may be taxed or regulated depending on the evolving world and trending concerns.
Similarly, investing in sectors or industries which may receive future government support or subsidies may provide potential supplemental growth or earnings without sacrificing any downside. Our pragmatic view is that it would be inconceivable that a future government would penalize a business for acting ethically or supporting its local community.
Detriments of ESG Investing (Cons of ESG)
The major con to ESG investing is that it eliminates certain viable and profitable industries and companies that have mostly fallen victim to the evolving world. Many tobacco, firearms, defense, and utilities companies were considered solid, safe, and defensive investments throughout the last century.
Many of these companies may continue to operate successful and mature businesses throughout our lifetimes and their absence from an ESG portfolio can be detrimental. Many of these businesses trade at fair or historically low valuations because of the lack of popularity and favor, possibly creating more opportunities as some funds have sold these investments over recent years.
Additionally, there is a lack of consensus on which industries and businesses should not be included in ESG funds, specifically among the gaming (gambling), alcohol, and defense sectors. A lack of transparency seems to arbitrarily disallow some companies while others are included in key indexes.
ESG investors must sacrifice some potential profits in return for sticking to strict ESG standards. Sometimes it may be a bit incidental regarding which companies get included and disclosed from leading ESG indices as trends or populism changes.
ESG funds represent responsible and moral ways to invest your money wisely and ethically simultaneously. Not all ESG funds are equal and be aware of the different inclusion criteria managers follow to determine or include their investments. Diversifying in funds is always a smart way to mitigate specific company risks and is our recommendation for most types of investors.
Consider investing in one or more of the above ESG funds today and know you prioritize profits and a sustainable and fair future.
Josh is a financial expert with over 15 years of experience on Wall Street as a senior market strategist and trader. His career has spanned from working on the New York Stock Exchange floor to investment management and portfolio trading at Citibank, Chicago Trading Company, and Flow Traders.
Josh graduated from Cornell University with a degree from the Dyson School of Applied Economics & Management at the SC Johnson College of Business. He has held multiple professional licenses during his career, including FINRA Series 3, 7, 24, 55, Nasdaq OMX, Xetra & Eurex (German), and SIX (Swiss) trading licenses. Josh served as a senior trader and strategist, business partner, and head of futures in his former roles on Wall Street.
Josh's work and authoritative advice have appeared in major publications like Nasdaq, Forbes, The Sun, Yahoo! Finance, CBS News, Fortune, The Street, MSN Money, and Go Banking Rates. Josh currently holds areas of expertise in investing, wealth management, capital markets, taxes, real estate, cryptocurrencies, and personal finance.
Josh currently runs a wealth management business and investment firm. Additionally, he is the founder and CEO of Top Dollar, where he teaches others how to build 6-figure passive income with smart money strategies that he uses professionally.