: Vanguard is rising its ESG workforce – are extra sustainable mutual funds on the best way?

Vanguard is not known for its wide range of environmental, social, and governance mutual funds. Only five are available in the US, compared to dozens at rival Blackrock and other companies.

With billions of dollars pouring into competing ESG products over the past year and a half, the fund giant could change its stance as it expands its expertise in the field.

Kaitlyn Caughlin, who oversees the company's product evaluation, wouldn't say if or when to expect new products, but noted that the company "is doing a lot of additional research right now".

The company recently set up an ESG product category team in the US with two dedicated ESG product managers and three support staff. In Europe there is a Head of ESG Strategy who leads a group of product specialists who are largely, but not exclusively, dedicated to ESG. These teams will work with others in Vanguard, both on ESG products and on ESG integration with conventional products.

The setting shows that Vanguard is expanding into space, but it may be dipping in the toe rather than fully accepting it, even if ESG is one of the hottest investment trends. After all, with $ 7.2 trillion in assets under management as of Jan. 31, Vanguard has fewer staff than other smaller mainstream companies, let alone ESG powerhouse fund families like Calvert or Parnassus.

Vanguard lags behind smaller mainstream companies in ESG fundraising and staffing. For example Invesco
+ 1.50%
is less than one-fifth the size of Vanguard by total assets under management, at $ 1.35 trillion as of December 31, 2020, but has 17 ESG ETFs and mutual funds in North America. Its largest Invesco Solar ETF
At $ 3.6 billion as of December 31, it is the fifth largest ESG fund in the US, ahead of Vanguard's largest ESG ETF, US equity ETF Vanguard ESG
+ 0.01%,
at $ 2.9 billion as of December 31.

Invesco has 13 people on its global ESG team, and Glen Yelton, Invesco's head of Americas ESG, says he will be hiring five or six more people.

The company has $ 8.7 trillion AUM as of December 31 and owns the iShares ETF brand. It has 10 US equity and fixed income ESG ETFs.

There is a lot of money to fight for. US SIF, an organization that has pursued sustainable investing since 1995, reported in late 2020 that 33% of professionally managed money in the US is invested sustainably, at $ 17 trillion out of $ 54 trillion. Sustainable investing covers a wide range of investments to take into account both financial return and social and environmental good, and ESG investing is the largest part of sustainable investing.

ESG grew steadily for years, but started at the end of 2019. The largest ESG ETF by assets under management – the iShares ESG Aware MSCI USA ETF
+ 0.15%
– was $ 13.4 billion at the end of 2020. As early as August 2019, it was only $ 286 million and was over $ 1 billion by the end of 2019, according to the ETF Research Center.

Invesco's 12-year solar ETF made more than $ 500 million in net worth in mid-2020 and then started the snowball. Vanguard's ESG US Stock ETF hit $ 500 million in mid-2019 and is now four times the size.

While ESG funds can be launched as traditional mutual funds or ESG funds, most new ESG funds are ETFs.

Vanguard mainly uses exclusive toughened glass screens

Better ESG data could change Vanguard's future means. Of Vanguard's five US-based ESG and mutual funds, four are index-based and use foreclosure checks to weed out unwanted sectors like tobacco.

However, the use of exclusion screens is ESG 1.0 as many ESG funds also have inclusion screens that specifically select stocks or sectors to include in their holdings depending on the fund's mission.

"One of the reasons we haven't implemented an inclusion-based index strategy is that we haven't felt that the information is consistent or of good quality," says Caughlin.

In a December report on fund companies' ESG exposure, Morningstar gave Vanguard the lowest ranking: “Passive ESG strategies don't differentiate funds as much from their broader universes as peers who explicitly incorporate ESG criteria to select companies with positive ESG Characteristics."

In addition to the US equity ETF ESG, the other exclusively index-based funds from Vanguard are the ESG International Stock ETF
ESG US Corporate Bond ETF
and the Vanguard FTSE Social Index Fund
a mutual fund. The fifth fund, a mutual fund of sub-advisor Wellington, is called Global ESG Stock Fund
Integrates exclusion and inclusion screens and is actively managed.

Vanguard's index funds use many of the popular negative environmental and social reviews, including reviews of companies in controversial industries such as tobacco, alcohol, adult entertainment, fossil fuels, nuclear power and weapons, as well as non-promotional companies for diversity. These general exclusion screens do not have governance filters.

These exclusion screens don't always filter out what investors think is possible. For example, the ESG US equity ETF has $ 23.1 million, or 0.78% of fossil fuel companies' assets, despite being screened for fossil fuels, according to fund screener As You Sow's website. This is not uncommon for index ETFs whose exposure is intended to mimic the broader stock index.

"Never cut into slices and dice"

Although Vanguard's FTSE Social Index Fund dates back to 2003, it didn't release its next ESG funds, the ESG US Stock ETF and the ESG International Stock ETF, until 2018. However, according to Caughlin, it's not what Vanguard does to bring many products to market.

"Our approach will never be to meet each investor in different ways," she says. "But we want to enable our investors to care about expressing their preferences or values ​​and build portfolios that deliver really good long-term investor results that will stay here."

There are no U.S. or global standards about how companies publish ESG data or what data they publish. The Sustainability Accounting Standards Board created a number of industry standards some time ago, and industry efforts over the past year, such as those from the Investment Company Institute and the CFA Institute, have been aimed at getting more corporate and fund disclosure.

The regulatory authorities also take greater account of sustainability. All of these reasons are why Vanguard is intensifying its research into ESG strategies to see how they fit into the framework of the mutual fund company, which, according to Caughlin, is focused on lasting investment themes.

"We're definitely looking at a number of different funds right now. So I don't feel like our job in ESG is done. But we're not going to market anything for ESG like we do for our other new product developments without it it reaches our very high bar, ”she says.

How Vanguard's ESG funds are performing

The performance of the FTSE Social Index Fund, which is designed to track the performance of the FTSE4Good US Select Index, has assets of USD 11.3 billion and a strong 10-year track record with an annualized return of 14.6%, which corresponds to the Outperforms Russell 1000 Reference Index
+ 0.10%
(Think about the S&P 500 index
+ 0.10%
and then another 500 companies). The much younger ESG US Stock ETF is up 36% on an annualized basis, outperforming the Russell 1000 and slightly outperforming BlackRock's iShare ESG Aware MSCI USA ETF
+ 0.15%,
This corresponds to an increase of 34% on an annual basis.

Vanguard views Wellington-advised Global ESG Stock Fund, which seeks companies with high financial productivity and strong governance, as an inclusion fund. Pointing to this fund in its report, Morningstar said, "Integrated ESG approaches at Vanguard are younger and more promising."

On an annual basis, it has risen by 46.5%, outperforming the MSCI ACWI Large Cap Index, its benchmark.

Caughlin indicated that investors may see more products like the Wellington Fund. The downside for investors can be higher fees than they are used to from Vanguard. The US equity ETF has an expense ratio of 0.12%. The Wellington Fund has an expense ratio of 0.58%. However, Morningstar says this is low for a no-load world equity fund, which is typically 1.05%.

"Given that we are dealing with disclosures, we could be looking for more talented active managers right now who can both outperform a certain benchmark while incorporating ESG best practices into their company selections," she says.

Debbie Carlson is a MarketWatch columnist. Follow her on Twitter @ DebbieCarlson1.

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