ShareBuilder 401k recently added Environmental, Social, Governance (ESG) funds) to the 401(k) line-up as investment options for our customers. There has been a lot of discussion about ESGs, and here’s some perspective to consider if these types of investments are a good fit for your own portfolio or not.
What Makes a Fund an ESG?
Investopedia provides a nice summary: ESG criteria are a set of standards for a company’s operations that socially conscious investors use to screen potential investments. Environmental criteria consider how a company performs as a steward of nature. Social criteria examine how it manages relationships with employees, suppliers, customers, and the communities where it operates. Governance deals with a company’s leadership, executive pay, audits, internal controls, and shareholder rights.
There can be a bit of subjectivity here like there can be in most any asset class but know that a fund or index will typically work to focus on one of these three categories to define companies that meet the criteria for it to be included in the fund. For example, an environmental fund often might include companies that are developing technology or products to reduce fossil fuels and carbon emissions – think electric cars, solar power, batteries that can store electricity for longer and longer periods of time, etc. It might also include clean water focused companies and many more. Many ESGs work to focus on excluding those companies that do not meet the criteria.
These funds are typically equity (stock) investments, and they will fit or be a subset within a larger asset class such as Large Cap Blend. The S&P 500 would fall in this asset class if this feels like we’re speaking Latin. We classify ESGs in our Specialty Fund list for our customers to consider.
How Do ESGs Funds Stack Up to Non-ESG Funds?
A loaded question, but like in every asset class, we would consider a lot of the ESG options subpar. For any new fund in any asset class, the fund may lack size to know if it will survive, may have high expenses, may not be well diversified, may not have a track record of performance near its benchmark or comparable asset class, an undefined or poorly defined benchmark, etc.
It’s just important to know that you need to carefully review a fund before you buy it no matter the asset class to try to ensure it’s a fund that will be around and perform in line with its index. Also, at ShareBuilder 401k we employ a proprietary method and parameters to review every fund made available in our investment roster to ensure it meets a high bar.
The good news is there are now a few ESGs that have risen to the top like the ones we just added to our fund line-up. As one proof point, while we all know there is no guarantee of future performance with any investment, when you look at these ESG funds we added versus other large-cap blend indexes such as the S&P 500 over various time periods, you see they are right in line and even better in some periods.
Will These Funds Be Good Investments?
Markets are volatile. Some asset classes are counter cyclical. Some never perform as well as others. Some perform better than others. And the list goes on. Its why financial companies can never guarantee performance and another reason of why it’s important to diversify your investment selections.
ESGs are a growing area of interest and in particular some parts like new energy are seeing innovation. This is one reason among others we’ve highlighted that this sector has the potential to be an investment area to consider as part of your portfolio. Time will tell. Of course, again we suggest you need to invest in other funds that cover other equity and bond asset classes beyond ESGs to build your portfolio.
Lastly, think through your investment needs, risk tolerance, and goals and determine if you want to allocate some percent or amount of your portfolio to ESGs. We hope this helped you think through if ESGs are right for you.