Vanguard aims to prove feel-good investing can deliver returns

By October 4, 2018 No Comments

Vanguard Group recently launched some of the cheapest funds yet featuring green and socially responsible companies, the latest example of do-good strategies that claim to deliver stock-market returns along with a clear conscience.

But for all the recent fervour among fund firms, few mom-and-pop investors are buying.

Vanguard, State Street, OppenheimerFunds and Nuveen are just a few of the firms that have jumped on the bandwagon, launching exchange traded funds that invest in firms with the lowest carbon emissions or the largest number of women on boards.

Since the start of 2016, 40 ETFs that invest based on environmental, social and governance criteria have been introduced, more than quintupling the number on the market, according to Morningstar.

But the 48 ETFs on the market together have just $5.3bn in combined assets, less than 0.15% of the $3.7tn US ETF industry.

The two new Vanguard ETFs exclude companies engaged in industries such as booze, adult entertainment, tobacco and weapons. The funds also try to sidestep firms that fail to meet certain diversity, human rights and environmental standards.

A recent survey of 1,500 ETF investors published by Charles Schwab provides some clues as to why investors aren’t putting their money in funds that match their professed values, including higher fees and concerns that righteousness comes at the expense of returns.

Vanguard’s new domestic equity ethical fund costs just $12 a year for every $10,000 invested, and its new international ETF is $15. Only three other such ETFs, known by the acronym ESG, are priced that low.

Yet the biggest hurdles may be structural. “Socially responsible” strategies have long been on the fringes of finance, and ESG is a relatively recent offshoot of it. Many ETFs are too new and too small to pass muster with the gate keepers at big brokerage firms. Regulations keep similar mutual funds out of most employer-sponsored retirement plans.

“It requires an investor to do much more homework and jump through additional hoops instead of just buying what’s readily available,” said Todd Rosenbluth, head of fund research at CFRA.

ESG evolved from socially responsible investing, an industry that traces its modern roots to the antiapartheid divestiture campaign of the 1980s, which prodded companies to withdraw from South Africa to protest the country’s institutionalised racial segregation.

After apartheid was dismantled, ethical investing focused on boycotting bad actors, like heavy polluters and human rights violators. But excluding huge swathes of the market raised concerns about sacrificing performance and diversification.

Instead of rejecting entire industries outright, many ESG strategies tilt toward the best corporate citizens. They proportion their portfolios based on how companies perform on issues like pollution and pay parity instead of using market value to determine how much to invest in each company, like most traditional indices.

ESG has won influential adherents, like pension funds in California, New York, Norway and Japan.

Assets in ESG and socially responsible mutual funds and ETFs world-wide grew 29% last year to nearly $1tn, and this year’s gains have been even bigger, according to a report published earlier this year by analysts at Goldman Sachs.

However, there are still barriers to widespread adoption. Many retirement savers invest exclusively through employer-sponsored savings plans, but only a handful of those include ESG options, in large part because of regulations that prohibit plan managers from considering anything other than the best economic interests of participants, explained Brian McCabe, a partner in the investment-management practice at law firm Ropes & Gray.

Employees can lobby their plan managers to add ESG options, or set up their own investment accounts independent of the company-picked fund lineup. Few go through that trouble.

The other hurdle is perception: It is hard to dislodge the decades-old assumption that such strategies mean sacrificing returns, a concern of 84% of the respondents to Schwab’s survey.

Proponents say the opposite is true, and that such strategies can beat the market by skirting potential pitfalls.

For example, analysts at index provider MSCI, a major provider of scoring in the industry, flagged governance problems at Facebook, Equifax and Wells Fargo months or even years before scandals broke into public view. That led some ESG funds to steer clear of them.

Whether that translates into long-term outperformance is less clear. MSCI’s plain-vanilla US stock index beat the ESG version over the past decade, but ESG won out when it came to indexes tracking developed markets in Europe, Australia and Asia, according to MSCI.

When it comes to ETFs in particular, few of the ESG offerings have been tested over the long haul. After a decade of steady gains in US stocks, it is hard to convince investors to pay higher fees for ESG strategies when they can get plain-vanilla index ETFs for as little as $3 a year for every $10,000 invested.

“You can show them all the studies, all the back tests, all the theory,” said Martin Kremenstein, head of retirement products and ETFs at Nuveen, the asset-management arm of TIAA, which has several ESG ETFs and mutual funds on the market. “But until they see performance over time, it’s always going to be a hurdle.”

Write to Asjylyn Loder at [email protected]

This article was published by The Wall Street Journal

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