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When you’re adding investments to your portfolio, how well they perform may not be the only question on your mind. Investors are increasingly considering ESG factors — environmental, social and governance principles — when they choose investments. And the number of ESG-focused options is growing.
Now you can seek returns and make an impact in the same portfolio. Research shows ESG funds often perform better than their traditional counterparts.
What is an ESG fund?
ESG funds are mutual funds graded using ESG (environmental, social and governance) principles. ESG funds invest in companies that aim to have a sustainable and societal impact in the world, such as those with a small carbon footprint or diverse leadership boards.
ESG funds are not individual stocks. They are a collection of multiple stocks grouped together. Buying a fund rather than an individual stock can decrease risk since a fund holds shares of many companies rather than just one. If one company represented within your fund goes out of business, the fund should weather it better than if you owned stock in a single company that goes under.
“Putting our investment dollars to work in ESG influences the behavior of the largest and most powerful multinational corporations in the world for the greater good of society," says Kenneth Chavis, a certified financial planner and Senior Wealth Manager at LourdMurray in Los Angeles. “To me, this illuminates the breadth of power the everyday investor has, and is an excellent way to make a large-scale, meaningful difference,”
But if influencing powerful companies to make meaningful change isn't a good enough reason to invest with ESG principles, there are two more: the potential for increased performance and reduced risk.
Studies from JUST Capital, Arabesque Partners and others have shown that ESG funds can not only match traditional funds in terms of performance, but that they often outperform them. As for risk, a 2019 white paper from the Morgan Stanley Institute for Sustainable Investing details a study comparing sustainable funds and traditional funds from 2004 to 2018.
The research showed that overall, sustainable funds have consistently shown a lower downside risk than traditional funds. And while some ESG funds are relatively new (particularly many passive ones), they’ve been able to show solid performance and resiliency in both good markets and bad.
“When we had healthy growth markets, like for the last few years, ESG funds performed quite well. This year, when we had such a significant decline, and even now when the markets are choppy, these funds have outperformed, on the whole. So the shorter track records of younger ESG funds do cover different types of markets,” says Jon Hale, the director of sustainability research for the Americas at Sustainalytics.
» Need more information? Learn how to get started with socially responsible investing
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Best-performing ESG funds
To determine the best ESG funds, we screened for U.S. equity funds with expense ratios less than 1% (an expense ratio is an annual fee charged to investors; if you invest $10,000 in a fund with a 1% expense ratio, you’ll pay $100 a year), minimum initial purchases of less than $2,500 and a high Morningstar sustainability rating.
Funds are ranked by their five-year performance. But keep in mind that a fund's past performance does not indicate its future performance.
» Some brokers are better than others. Read our roundup of top-rated brokerages for mutual funds
Amana Growth Investor
Brown Advisory Sustainable Growth Investor
Calvert Equity A
Delaware Ivy Large Cap Growth Fund A
Payson Total Return
Praxis Growth Index A
Pax Large Cap Fund Individual Investor
Glenmede Quant US Large Cap Growth Equity Portfolio
Applied Finance Select Investor
Cheapest ESG funds
Sustainable funds used to get a bad rap for being expensive, and it's true that the funds above may carry higher expense ratios than their traditional peers.
» How much does a fund cost? Estimate a fund’s expenses with a mutual fund calculator
Impact investors are often willing to pay a bit more to ensure they're investing in a way that aligns with their values, but if you're also concerned with costs — and all investors should be — the following funds are among the lowest-cost ESG funds available.
To determine the lowest-cost ESG funds, we screened for U.S. equity funds with minimum initial purchases of less than $2,500 and a high Morningstar sustainability rating. Funds are ranked by their expense ratios.
Fidelity Series Small Cap Discovery
Fidelity U.S. Sustainability Index
VALIC Company I U.S. Socially Rspnb
Fidelity Small Cap Discovery
TIAA-CREF Social Choice Low Carbon Equity Fund
Fidelity Growth Strategies
JPMorgan US Sustainable Leaders A
Praxis Growth Index A
Commerce MidCap Growth
ETFs, or exchange-traded funds, are another form of low-cost fund. ETFs are similar to index funds and other passively managed funds. The main difference is that ETFs can be traded throughout the day similar to stocks. Just as there are ESG mutual funds and ESG index funds, there are also ESG ETFs. These ETFs will follow the same tenets of environmental, social and governance that other types of ESG funds do.
» What's a small-cap ETF?
How to choose the best ESG funds for you
Deciding you want to invest in ESG funds adds some extra considerations you may not have when picking more conventional funds.
1. Understand the difference between active and passive funds
Active and passive funds have different pros and cons. Make sure you know their differences before you dive in.
Strategy. Actively managed funds try to beat stock market performance. This strategy may sound good in theory, but overall, actively managed funds often underperform their passive counterparts. According to the S&P Dow Jones Indices year-end scorecard, 70% of domestic equity funds underperformed the S&P Composite 1500® in 2019. Passively managed funds are also known as index funds because they are invested to reflect a specific market index, such as the S&P 500. These funds mirror the performance of the index they track.
Cost. Keep in mind, higher fees can also negate higher returns. Many of the funds listed as "best overall" above are actively managed, whereas the funds on the low-cost list are passive. Actively managed ESG funds tend to be more expensive than passively managed funds, so if you’re looking to add sustainable investments to your portfolio with a smaller price tag, passively managed funds or ESG ETFs may be a better option.
Availability. There are far more actively managed ESG funds than passively managed ESG funds, but passive funds are becoming more common. According to Morningstar, the number of available sustainable index mutual funds and exchange-traded funds has more than doubled in the last three years — as has the money invested in them. Still, you’ll have more choice if you’re looking at active funds.
When choosing between active and passive funds, Chavis emphasizes that the decision depends on considerations such as your investment goals, your investing experience and your tax situation. He also recommends consulting an investment professional during this process
2. Decide where you want to have an impact
In addition to checking expense ratios, make sure an ESG fund’s mission speaks to you. “An investor should look for an ESG fund that is in alignment with their goals. Let’s say social impact is of the utmost importance to you, specifically regarding diversity, equity and inclusion initiatives. You should seek a fund that rewards, in investment dollars, companies for high diversity, equity and inclusion scores on their boards, executive teams and with their employment practices,” says Chavis.
» Is sustainability just a label? Learn about greenwashing
Think about whether there are particular missions you’d like to support with your investment dollars, such as clean water, renewable energy or women in leadership. If there’s an impact area that’s really important to you, that may outweigh a slightly higher expense ratio.
3. Consider your existing investments
Before adding any new investments to your portfolio, think about how an ESG fund would fit in. Be sure you're not overinvesting in a particular industry or asset class.
If you’d like to invest in ESG funds but don’t want to choose your investments yourself, there are several robo-advisors that offer ESG portfolios for no extra charge.
» View our list: The best EV stocks
4. Understand your ESG fund’s impact
Maybe you’ve added a few ESG funds to your portfolio. So how do you know if those investment dollars actually made a difference?
“What I would look for, and what investors should insist upon, is an impact report,” says Hale. “That will give you a way to assess the impact of a fund as an investment. Impact reports talk about things like shareholder engagement, or the portfolio’s carbon footprint or gender diversity on the Boards of the companies held. That’s a good way to gain a sense of what impact you’re having as an investor.”
ESG funds may periodically release an impact report, or you can probably request one from the fund managers.
What's the easiest way to invest responsibly?
Using a robo-advisor that offers a socially responsible portfolio (which are typically built from ESG-graded exchange-traded funds) is the easiest way to get started with sustainable investing. Of the robo-advisors with socially responsible portfolios that NerdWallet reviews, the following currently offer socially responsible portfolios or access to ESG investments and earn a star rating of 4.5 or higher.
Socially responsible portfolio offerings
Provides three impact portfolios to choose from: Broad Impact, Climate Impact and Social Impact.
Ellevest Impact Portfolios are invested in up to 53% ESG and impact funds.
Categorizes ETFs that support various social and environmental causes.
Offers investments in themed areas such as clean energy and companies with a greater representation of women in senior leadership roles.
Offers a Socially Responsible Managed Portfolio option.
* These robo-advisors are NerdWallet advertising partners.