First, with so many ESG funds available, there is no universal definition. Each one has its own set of criteria. “Just because the fund has ‘ESG’ in the title, it doesn’t mean it meets your definition of ESG,” says Jonathan Kvasnik, Cherokee Investments, quoted in a June 18, 2018, article by Robert Powell in USA Today, “ESG funds: What you need to know about socially responsible investing.” It’s important to become very clear about your personal views on social issues, environmental policy, and corporate governance before shopping for a fund.
Another factor to consider is your responsibility to your own well-being. Does owning ESG funds help or hurt an investor’s bottom line? That all depends. While some ESG funds do a little better than owning an index fund, in my experience most do a little worse. One of the biggest problems is that most ESG funds have much higher fees than their passive counterparts. Vanguard notes the average cost of an ESG fund is 1.06%.
Vanguard and Dimensional Fund Advisors (DFA) offer two of the lowest cost SRI funds with costs of 0.28% and 0.18% respectively. To ascertain how SRI funds fare over time, let’s compare these two funds with their non-SRI equivalents.
Dimensional Fund Advisors specializes in constructing low-cost, passive mutual funds based on the research of Eugene Fama, recipient of the 2013 Nobel Prize in economics. These funds are owned mostly by institutional investors (like the South Dakota Investment Council) and clients of some fee-only advisors.
DFA offers a fund called the US Core Equity 2 Portfolio. It holds a broad range of 2,882 US companies, from the largest like Apple to the smallest, called micro-caps. Over the past five years the fund has earned 11.94% and over 10 years it’s returned 11.67%. The expense ratio of the fund is 0.22%, which is about 1.00% under the cost of most equity funds.
DFA offers an SRI version of the fund, the US Social Core Equity 2 Portfolio. It excludes companies that deal in nuclear weapons, tobacco, alcohol, gambling, abortions, pornography, landmines, child labor, stem cell research, or the Republic of Sudan. The fund has a slightly higher expense ratio of 0.28%, due to the cost of actively excluding 18%, or 530, of the funds in its sister offering. The fund returned 11.56% over the past 5 years and 11.15% over 10 years. That is 0.38% less over five years and 0.52% less over 10 years than the sister fund.
While a 10-year return of 0.52% less doesn’t sound like much, it makes a difference. A $100,000 investment in the SRI fund grew to $287,803 while the same investment in the non-SRI fund grew to $298,597, an additional $10,794.
Vanguard’s FTSE Social Index Fund didn’t compare quite as well with its sister fund. A $100,000 investment in the equivalent Vanguard Large Growth fund earned almost $100,000 more than the Social Index Fund over 10 years.
Investing in ESG funds won’t hurt the companies you exclude or help the overall returns of your portfolio. Yet the value of investing that aligns with your beliefs may still be worthwhile for you.
However, an even more effective way to influence companies you believe to be socially irresponsible is to boycott them. Refusing to purchase their products or services will make a bigger impact than refusing to own their stocks. If, as well, you maintain a more broadly diversified investment portfolio, you may also be able to donate larger amounts directly to the causes you support.