From an indexing perspective, Vanguard ESG U.S. Stock ETF (ESGV) and Vanguard ESG International Stock ETF (VSGX), both managed by Vanguard Equity Index Group, were launched on September 18, 2018. To accommodate ESG investors with an active preference, Vanguard Global ESG Select Stock Fund (VESGX – Admiral™ Shares; VEIGX – Investor Shares), which is managed by Wellington Management Company, was launched on June 5, 2019.
We recently spoke with Rich Powers, Vanguard’s head of ETF product management, about how ESG investing has grown in the ETF market.
How has ESG investing evolved over the past year?
It’s important to remember that mutual funds employing an ESG screen have been a fixture in the investing landscape for decades. We’ve offered an ESG mutual fund, Vanguard FTSE Social Index Fund (VFTAX – Admiral Shares), since 2000.
But the ESG groundswell among ETF investors has been especially significant during the past year. There are about 100 ESG ETFs available now, which is about 20% more than 18 months ago. And assets under management in ESG-focused equity ETFs have risen from about $10 billion in July 2018 to nearly $18 billion as of September 2019.*
Also, ESG has become an increasingly important part of the dialogue in the investment community. At just about every ETF conference I attend, or at most client meetings, ESG is a prime topic.
U.S.-domiciled equity ESG ETF assets have grown
Source: Morningstar, Inc., as of September 30, 2019.
What are some of the key themes of those discussions?
ESG investors are very interested in the question of how best to align their investment goals with their values. In particular, we find that with so many options to choose from, investors value an ESG methodology that is understandable and straightforward. At the same time, we’re also hearing that many investors look for the same characteristics when making ESG investment decisions that they do with any other ETF—such as low tracking error, low cost, diversification, and liquidity.
How should investors choose an ESG approach?
Our Investment Strategy Group published a paper last year, ESG, SRI, and Impact Investing: A Primer for Decision-Making, which offers a framework for investors to follow when considering ESG. Investors should first try to identify the values and goals that matter most to them, then seek the investment strategy that most closely matches those objectives.
The research illustrates that there are many ways to align ESG investing preferences: through screening, by integrating ESG factors into company evaluation, or by investing in areas with the goal of making an impact. While many given strategies may be labeled “ESG,” each can result in a portfolio that is quite different from others.
What factors should investors consider when evaluating ESG portfolio options?
We always encourage investors to look at the methodology of a fund—the ingredients, if you will. It’s important to remember that what qualifies as ESG is not only in the eye of the beholder. It is also quite reliant on data transparency and can be subject to change. Here’s an example: Say a company produces solar panels but is found to be engaging in controversial labor practices. From an ESG perspective, is that company great because it generates renewable energy or sub-par because of the controversy? And what happens when the company cleans up the labor issues?
Screened indexes like those our ETFs track may exclude the solar company for the controversy (rather than explicitly include it for solar production) and then “re-admit” the company to the benchmark after its conduct is remediated. We view that as a positive. Any single fund’s portfolio can (and should) evolve over time, as new pertinent company data becomes available, and as companies change the way they act.
In other words, ESG determinations can be dynamic, rather than static?
That’s right. While these types of changes may seem unique to ESG, it’s actually pretty similar to how a company may migrate between growth or value indexes. For instance, over the last couple of years, major U.S. equity benchmark providers have migrated Microsoft from value to growth at differing times. The metrics-based rules each provider uses scored Microsoft in different ways. What some may consider to be an objective characteristic isn’t necessarily viewed the same way by all investors. Similarly, when ESG indexers judge companies, they may not all evaluate a company in an identical way. And within an index, a company’s classification at one point in time may not be permanent.
*Source: Morningstar, Inc., as of September 30, 2019.
You must buy and sell Vanguard ETF Shares through Vanguard Brokerage Services (we offer them commission-free) or through another broker (which may charge commissions). See the Vanguard Brokerage Services commission and fee schedules for full details. Vanguard ETF Shares are not redeemable directly with the issuing fund other than in very large aggregations worth millions of dollars. ETFs are subject to market volatility. When buying or selling an ETF, you will pay or receive the current market price, which may be more or less than net asset value.
All investing is subject to risk, including the possible loss of the money you invest. Investments in stocks issued by non-U.S. companies and governments are subject to risks including country/regional risk and currency risk. These risks are especially high in emerging markets. Diversification does not ensure a profit or protect against a loss.
ESG funds are subject to ESG investment style risk, which is the chance that the stocks screened by the index sponsor for ESG criteria generally will underperform the stock market as a whole or that the particular stocks selected, in the aggregate, will trail returns of other funds screened for ESG criteria.