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Funds for Uncertain Times: Sustainable funds

What funds are helping investors navigate 2020’s uncertain markets?

We initially looked at how alternative funds might help fund investors. Now, we’re focusing on sustainable funds, which have become increasingly important in the Covid-19 market environment. 

Here’s what investors and advisors alike should know about sustainable funds:

  • What are sustainable mutual funds?
  • Is sustainable investing the same as socially responsible investing?
  • What are ESG issues?
  • How could sustainable funds help you in 2020’s uncertain markets?
  • What are some sustainable fund examples?

We’ve been involved with sustainable responsible investing for decades, so we turned to our investment advisors for answers to these FAQs.

What are sustainable funds?

Sustainable funds are mutual funds that evaluate companies based on financial criteria as well as environmental, social and governance (ESG) factors in order to get a clearer picture of a company’s strengths and weaknesses, better manage risk, and ideally improve long-term results.

A Bank of America study found that “ESG metrics have shown to be better at signaling a company’s future earnings than traditional financial measures like its level of debt. They also helped investors avoid losses related to ‘ESG blunders’—when companies become embroiled in regulatory and/or public relations crises.” 

Is sustainable investing the same as socially responsible or socially conscious investing?

What used to be called socially responsible or socially conscious investing is now more commonly known as sustainable investing or sustainable responsible investing (SRI) or ESG investing.

Socially responsible investing used to be considered  a “do-gooder” approach, and it tended to focus on avoiding certain companies. Sustainable investing covers a wider range of issues under the ESG umbrella, and it includes many different strategies.

“Environmental, social, and governance investing has evolved from funds that simply screened out undesirable companies like polluters or sellers of tobacco to strategies that apply a matrix of sophisticated screens to assess the best and worst players in every industry and actively seek to have a positive impact in many ways,” Morningstar explained.

What is ESG and why is it important?

ESG—environmental, social and governance—covers some of today’s most pressing concerns.

The “E” in ESG is perhaps the easiest to understand: it looks at environmental issues, such as climate change, emissions, renewable energy, and pollution. 

“Until fairly recently, environmental damage was tolerated as an unwelcome but acceptable side effect of economic growth. Now, however, environmental damage such as pollution is starting to dampen economic growth,” Deutsche Bank noted.

The “S” in ESG has often been overlooked, but it’s been a key consideration in the Covid-19 pandemic. The social component of ESG looks at how a company affects society, including its employees, customers, and supply chains. Social issues include product safety, labor standards, fair wages, and health care. 

“The market will tend to reward those companies that minimize their exposure to these social issues—selling controversial products, relying upon materials from geopolitical hot spots and using an unpredictable labor force can hurt profits and increase volatility,” S&P Global explained. 

The “G” in ESG looks at how a company is managed, including its executive compensation, lobbying and political efforts, and oversight and accountability. 

“A company’s resilience and contingency planning, especially in times of crisis, are crucial for its long-term performance. Hence, investors will have a heightened focus on these governance (“G”) areas,” State Street reported in an April 2020 report.

Why would I invest in a sustainable fund in 2020? 

Sustainable funds could help you weather volatile markets and manage risk, and that could help you stay on track to reach your financial goals. 

“Morgan Stanley found that in years of market turbulence, including 2008, 2009, 2015 and 2018, sustainable funds’ downside risk was substantially smaller than traditional funds,” CNBC reported. And these funds also did well in the volatile first quarter of 2020, as Morningstar and the Wall Street Journal found.

Companies with strong ESG ratings are “the quality companies of the 21st Century, and quality companies tend to hold up better than their lower-quality counterparts in difficult markets,” Morningstar explained.

A majority of advisors (70%) in Nuveen’s 5th annual responsible investing survey said “superior risk management is the top reason why their high-net-worth clients invest in RI [responsible investments].”

This may explain why assets in ESG funds have increased dramatically in the first half of 2020 (chart from BlackRock). 

Assets in Sustainable Funds are Growing Fast

What are some examples of sustainable funds?

There are so many sustainable funds and ETFs available today that it can be challenging for investors to determine which funds to own now. The sustainable fund universe includes actively managed funds, index funds, sector-specific funds, broadly diversified funds, equity and bond funds and ETFs. 

Some funds invest in a sustainable way but they aren’t named or marketed as sustainable or ESG funds, which can make it harder for investors to find them. 

Here are a few examples of diversified sustainable funds with market-level risk, including both self-identified sustainable funds and those that currently have strong environmental, social and corporate governance (ESG) ratings. These examples are not intended to be a recommendation. Talk to your investment advisor about which funds are appropriate for you.

Self-identified sustainable funds

These funds are usually easy to spot because they often have ‘sustainable’ or ‘ESG’ in their names. These funds often have decades of experience and comprehensive strategies including screening companies by ESG, avoiding objectionable companies, and engaging with companies to help them move forward. 

Sustainable fund example: Brown Advisory Sustainable Growth (BIAWX), TIAA-CREF Social Choice Equity Fund (TICRX)

ESG consideration funds

These funds may own a portfolio of strong ESG companies, but they aren’t explicitly labeled or marketed as sustainable funds. Morningstar calls them ESG Consideration funds: “Unlike fully committed sustainable funds, ESG Consideration funds do not apply ESG criteria to every investment decision...They are best thought of simply as funds that consider ESG information to be relevant to a thorough investment process,” Morningstar explained. 

Sustainable fund example: Polen Growth (POLRX), Vanguard US Growth (VWUSX).

Have more questions about sustainable investing or want to learn more about FundX's approach to sustainable investing?

FundX has been managing sustainable portfolios for more than 20 years. Click here to contact a FundX advisor.

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