Famous economist Milton Friedman may have argued that a company’s only responsibility was to its shareholders, not the public or society at large, but that doesn’t mean investors must agree with his views.
For investors looking to make environmental, social and governance, also known as ESG, considerations are a key component of their investment strategy, and an ESG fund can be a great choice for a core portfolio holding.
“ESG funds represent an opportunity to align your investments with your personal beliefs, practice social responsibility, good governance and sustainability, and put your money where your mouth is,” says Alex Budak, lecturer at the University of California-Berkeley’s Haas School of Business.
Whether combating climate change, promoting worker rights or advocating for better corporate governance, ESG funds can provide a viable investment vehicle to support causes while reaping the benefits of positive long-term investment returns.
To help investors find the best ESG funds on the market, our team assessed the current universe of offerings against several criteria, including the level of assets under management, expense ratios, management style and level of diversification.
Best ESG ETFs
Compare the best ESG ETFs
Why other funds didn’t make the cut
We began our rankings by screening for ESG funds in the exchange-traded funds category. While mutual funds have their uses, ETFs offer lower fees and better tax efficiency. These two traits make them flexible vehicles for self-directed investors.
Next, we excluded actively managed ESG funds, preferring to focus on passively managed ESG funds that track an external benchmark index. This was done for transparency purposes. Because the underlying methodologies for these indexes are published online, prospective ESG investors can understand exactly how their ESG fund selects its portfolio, which factors it assesses and how it weighs these factors.
The next criterion we applied to filter out less competitive funds was expense ratios. All else being equal, higher fees can cause long-term drags on total returns. Therefore, we set an upper limit of 0.25% for expense ratios for inclusion on this list.
We also set a minimum limit for how many assets under management an ESG fund must have accrued to make this list. Generally, ETFs with a higher AUM are at a lower risk of shutting down. A higher AUM also represents investor confidence in a fund and can provide economies of scale. Accordingly, all funds on this list had to meet a minimum $1 billion AUM requirement and thus come from two providers with a strong reputation and track records in the fund industry: Vanguard and BlackRock.
Finally, our ranking of the best ESG funds included criteria for broad diversification. That is, ESG funds tracking only certain stocks or bonds were excluded. For example, ESG funds tracking only small-cap stocks, corporate bonds or technology sector stocks were left out.
As a result, the ESG funds that made this list offered broad diversification across multiple market-cap sizes, sectors, bond issuers, bond maturities and bond credit ratings. This makes them suitable as core holdings for a range of ESG-conscious investors.
Methodology
Our curated rankings of the top ESG funds were created by applying a screen of several “must-have” metrics:
- Fund type: All ESG funds on this list use the ETF structure.
- Sufficient AUM: All ESG funds on this list have an AUM of at least $1 billion.
- Expense ratios: All ESG funds on this list have an expense ratio of 0.25% or lower.
- Management strategy: To qualify for this ranking, an ESG fund must be passively managed by tracking a benchmark index.
- Broad diversification: We only consider equity ESG funds that hold stocks from more than one market capitalization size and most of the 11 stock market sectors. For bond ESG funds, only those that included multiple issuers, maturities and credit ratings were included.
An experienced fund analyst selected the funds above, but they may not be right for your portfolio. Before purchasing any of these funds, do plenty of research to ensure they align with your financial goals and risk tolerance.
Final verdict
For investors who want to consider factors other than financial metrics when making responsible investments, ESG funds offer an easy way to put that into play. These professionally managed investment products can help investors align their investment strategy with an ESG-focused philosophy without exhaustive research and time spent on portfolio management.
Our pick for the best ESG fund is Vanguard ESG U.S. Stock ETF (ESGV) due to a combination of low fees and high diversification. With an expense ratio of 0.09%, this ETF is the cheapest on our list, costing just $9 in annual fees for a $10,000 investment. By tracking the FTSE US All Cap Choice Index, ESGV provides exposure to over 1,400 small-, mid- and large-cap U.S. stocks from all of the 11 market sectors.
What are ESG funds?
ESG funds are investment vehicles that consider environmental, social and governance factors when selecting their portfolio of underlying securities. Whereas non-ESG funds may only consider financial metrics such as a stock’s liquidity, market-cap size, volatility or other factors, ESG funds go a step further to prioritize responsible investing.
Each part of the ESG acronym deals with different nonfinancial factors. For example, the environmental portion usually assesses how a company’s operations and presence affect the Earth. Factors such as carbon footprint, energy usage, impact on climate change and pollution are commonly evaluated.
The social portion of ESG funds usually includes screeners that assess how a company interacts with its stakeholders beyond shareholders. This can include employees, customers, members of various communities or particular demographic groups. A company’s labor practices, diversity, inclusion, and human rights track record may be assessed here.
Finally, the governance portion of ESG funds screens for ethical leadership and management. This can include conditions on executive compensation, risk management and internal controls, privacy, transparency and shareholder rights.
By screening for these factors, whether based on a proprietary rules-based methodology or via an externally provided index, ESG funds aim to expose companies with better environmental, social and governance metrics than their peers.
Frequently asked questions (FAQs)
The ESG rule for retirement funds, also called the Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights, refers to recent guidelines set by the Employee Benefits Security Administration within the U.S. Department of Labor. In short, the ESG rule allows fiduciaries like 401(k) plan sponsors to consider ESG factors when selecting available investments and undertaking proxy voting for stocks held in retirement plans.
Vanguard offers several ESG-oriented funds, both in ETF and mutual fund form. These funds track an external benchmark index holding companies with high scores on ESG metrics. Examples include the Vanguard ESG U.S. Stock ETF (ESGV) and the Vanguard ESG International Stock ETF (VSGX). Investors can check Vanguard’s website for its current list of ESG fund offerings.
Whether ESG funds are a good investment can depend on several factors, including your personal investment goals, risk tolerance and values. Investors should determine their desired asset allocation, such as the proportion of stocks to bonds, based on these factors.
Consider selecting an ESG fund with screeners and underlying holdings that align with your values, and understand its ESG scoring criteria. Keep in mind that compared to regular index funds, ESG funds may have higher fees. They can also lack exposure in some market sectors, such as energy, and be overexposed in others, such as technology. If your goal is to invest passively in the entire market, an ESG fund may not be broad enough for your needs.
