A client recently asked me about the differences between the regular investment funds we use and Environmental, Social and Governance (ESG) funds.

It’s a great question that goes to the heart of whether responsible investing is right for you. With literally trillions of dollars flowing into ESG investments, the fund industry is becoming increasingly sophisticated in constructing ESG products that meet the goals of responsible investors.

Those goals are typically to avoid investing in companies that go against your personal beliefs while still enjoying the benefits of a broadly diversified portfolio at a low cost.

Vanguard, the world’s second largest fund company, issued a series of ESG funds last year. To get a taste of the differences between an ESG and a regular fund, I compared the Vanguard ESG U.S. Market ETF (ESGV) with the Vanguard Total Market ETF (VTI).

The index tracked by the Vanguard ESG fund screens out companies involved in adult entertainment, alcohol and tobacco, weapons, fossil fuels, gambling and nuclear power. It also excludes companies that don’t meet U.N. global compact sustainability principles or that fail to meet appropriate diversity criteria.

The top five companies (by portfolio weighting) screened out of the fund include some surprising names. Here they are, along with the reason given by Vanguard for their exclusion:

  • Berkshire Hathaway—Lacks a transparent diversity policy and management system
  • Johnson & Johnson—Human rights violation for a product that’s alleged to cause cancer
  • Exxon Mobil—Fossil Fuel
  • Chevron—Fossil Fuel
  • Boeing—Weapons Manufacturing

 

Berkshire Hathaway in an interesting case. It’s folksy Chairman and CEO, Warren Buffett, has long been held up as a paragon of integrity and openness. Yet, on ESG matters, he takes a very business first approach. A recent article in Corporate Knights magazine detailed ESG problems in Berkshire Hathaway’s sprawling collection of businesses, including coal and other fossil fuel production, a lack of concern about climate risks and poor disclosure of environmental performance.

The ESG fund’s top five over-weighted companies are all technology giants.

  • Apple
  • Microsoft
  • Amazon
  • Facebook
  • Alphabet

 

Vanguard’s ESG U.S. Market ETF is very reasonably priced with a management expense ratio of just 0.12%. Though more expensive than the Total Stock Market ETF’s MER of 0.03%, it can hardly be considered expensive when the average mutual fund fee in Canada is 2.3%.

The ESG fund was launched on September 18, 2018 and, thus far in its short life, its returns have compared well to the Total Stock Market fund. As of May 29, it had returned -3.5% since inception compared to -4.4% for the Total Stock Market ETF. That difference is likely due to the overweight in the high-flying tech giants mentioned previously.

The most significant difference between the two funds is the loss of diversification when you purchase the ESG fund. But let’s put that in context. This Vanguard article says the ESG fund still covers “more than 80%” of the U.S. market.

At PWL, we’ve looked closely at the issue of diversification in ESG funds. Our analysis of the wide body of research on the topic has led us to the conclusion that, if executed properly, an ESG portfolio will likely have a similar risk-return profile as a non-ESG portfolio over the longer term.

I personally believe giving up some diversification is worth it to own investments that reflect my concerns about importance of environmental sustainability, ethical corporate behavior and social responsibility.

To learn more about responsible investing, I invite you to read our free eBook—Responsible Investing: Putting Your Money Where Your Values Are. This is a topic I love to discuss so feel free to contact me with your questions and comments.