Environmental, Social and Governance (ESG) Funds – Investor Bulletin (2023)

Feb. 26, 2021

Funds such as mutual funds and ETFs that focus on environmental, social, and governance principles (ESG Funds) have gained popularity with investors over time. Investors may hear about these funds from financial professionals, from investment-focused online sites, or even from popular media. The SEC's Office of Investor Education and Advocacy is issuing this bulletin to educate investors about ESG Funds, including important questions to ask if considering whether investing in them is right for you.

What is an ESG Fund?

Funds, like ETFs and mutual funds, may consider a wide range of factors that are consistent with their objectives and strategies when selecting investments. This can include ESG, which stands for environmental, social, and governance.

ESG investing has grown in popularity in recent years, and may be referred to in many different ways, such as sustainable investing, socially responsible investing, and impact investing. ESG practices can include, but are not limited to, strategies that select companies based on their stated commitment to one or more ESG factors —for example, companies with policies aimed at minimizing their negative impact on the environment or companies that focus on governance principles and transparency. ESG practices may also entail screening out companies in certain sectors or that, in the view of the fund manager, have shown poor performance with regard to management of ESG risks and opportunities. Furthermore, some fund managers may focus on companies that they view as having room for improvement on ESG matters, with a view to helping those companies improve through actively engaging with the companies.

(Video) Environmental, Social, and Governance Issues in Investing: An Academic Perspective

Funds that elect to focus on companies’ ESG practices may have broad discretion in how they apply ESG factors to their investment or governance processes. For example, some funds integrate ESG criteria alongside other factors, such as macroeconomic trends or company-specific factors like a price-to-earnings ratio, to seek to enhance performance and manage investment risks. Other funds focus on ESG practices because they believe investments with desired ESG profiles or attributes may achieve higher investment returns and/or encourage ESG-related outcomes. For example, some ESG funds select companies that have shown their commitment to a particular ESG factor, such as companies with policies aimed at minimizing their negative impact on the environment. Some funds may implement shareholder voting rights in particular ways to achieve ESG goals, while others may only focus on selecting investments based on ESG criteria.

Fund managers focusing on ESG generally examine criteria within the environmental, social, and/or governance categories to analyze and select securities.

  • The environmental component might focus on a company’s impact on the environment—for example, its energy use or pollution output. It also might focus on the risks and opportunities associated with the impacts of climate change on the company, its business and its industry.
  • The social component might focus on the company’s relationship with people and society—for example, issues that impact diversity and inclusion, human rights, specific faith-based issues, the health and safety of employees, customers, and consumers locally and/or globally, or whether the company invests in its community, as well as how such issues are addressed by other companies in a supply chain.
  • The governance component might focus on issues such as how the company is run—for example, transparency and reporting, ethics, compliance, shareholder rights, and the composition and role of the board of directors.

An ESG fund portfolio might include securities selected in each of the three categories—or in just one or two of the categories. A fund’s portfolio might also include securities that don’t fit any of the ESG categories, particularly if it is a fund that considers other investment methodologies consistent with the fund’s investment objectives.

ESG investing is not limited to ETFs and mutual funds. Other types of investment products, like exchange-traded products that are not registered under the Investment Company Act of 1940, might also consider ESG factors in selecting an investment portfolio.

Be sure you understand what you are investing in.

If you are considering investing in an ESG Fund, you should know that all ESG Funds are not the same. It is always important to understand what you are investing in, and to be sure a fund, or any other investment, will help you achieve your investment goals. In addition, you will likely want to consider whether a fund’s stated approach to ESG matches your investment goals, objectives, risk tolerance, and preferences.

(Video) Environmental, Social, and Governance (ESG) Aware Investments

Here are some things to consider:

  • Some factors are not defined in federal securities laws, may be subjective, and may be defined in different ways by different funds or sponsors. There is no SEC “rating” or “score” of E, S, and G that can be applied across a broad range of companies, and while many different private ratings based on different ESG factors exist, they often differ significantly from each other.
  • Some funds may focus on ESG investing, while others consider ESG factors alongside other more traditional factors.
  • Different funds may weight environmental, social, and governance factors differently. For example, some ESG Funds may invest in companies that have strong governance policies, but may not have the environmental or social impact you may want to encourage through your investment in the fund.
  • Different funds may focus on different specific criteria within a factor. For example, one fund may focus on shareholder rights for “governance,” while another focuses on board of directors’ diversity.
  • Some ESG fund managers may consider data from third party providers. This data could include “scoring” and “rating” data compiled to help managers compare companies. Some of the data used to compile third party ESG scores and ratings may be subjective. Other data may be objective in principle, but are not verified or reliable. Third party scores also may consider or weight ESG criteria differently, meaning that companies can receive widely different scores from different third party providers.
  • You can find more information about how a fund incorporates ESG and how it weighs ESG factors in the fund’s disclosure documents. The fund’s prospectus contains important information about its investment objective and strategies, and its shareholder report contains both a list of its top holdings and a graphical representation of its holdings by category. These documents, and in some cases supplemental information, are available on funds’ websites.
  • Some funds that don’t have “ESG” in the name may still incorporate elements of ESG investing into their portfolios. Consider comparing an ESG Fund’s portfolio to other fund portfolios to be sure you are investing in a fund that is consistent with your investment goals.
  • Funds’ websites may also have policy statements that more fully explain their ESG practices, and other information such as customized statistics about the relevant ESG attributes or approaches used by the fund.

Greenwashing is the act of exaggerating the extent to which products or services take into account environmental and sustainability factors. Funds and advisers that engage in greenwashing may exaggerate or overstate the environmental and sustainability practices or factors considered in their investment products or services, while labeling and marketing themselves in a manner that makes it difficult for investors to distinguish them from funds and advisers that are truly using environmental and sustainability strategies. Other entities or industry professionals may also engage in greenwashing. For example, companies may exaggerate or overstate the environmental and sustainability aspects of their products or services or make unsupported claims about taking environmental or sustainability actions.

Understand What an ESG Investment Strategy Could Mean for You

As with any investment, you could lose money investing in an ESG Fund.

  • A portfolio manager’s ESG practices may significantly influence performance. Because securities may be included or excluded based on ESG factors rather than other investment methodologies, the fund’s performance may differ (either higher or lower) from the overall market or comparable funds that do not employ similar ESG practices.

What this may mean for you: ESG funds may perform differently than other funds without the ESG parameters.

  • Certain industries may be excluded from some ESG Fund portfolios. However, some ESG Funds may still invest in “best in class” companies within commonly excluded industries. For example, an ESG Fund could invest in a certain company within an industry where companies commonly have a large carbon footprint because that company demonstrated a commitment to improving its policies and practices on environmental issues. Moreover, companies which may score poorly on one ESG factor (such as carbon footprint) could be selected because they score well on another ESG factor (strong governance) or because the fund manager has plans to engage with the companies to improve their performance on ESG issues.

What this may mean for you: One of the most important ways to reduce the overall risk of investing is to diversify your investments. You should read the fund’s disclosure documents closely to be sure you understand what the fund is—and is not—invested in, and how its ESG orientation may affect its risk.

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  • Some funds that consider ESG may have different expense ratios than other funds that do not consider ESG factors.

What this may mean for you: You should always evaluate a fund’s expenses. Paying more in expenses will reduce the value of your investment over time.

Be sure to consider all of your goals when weighing any potential benefits and risks to making a particular investment.

InIn the Matter of BNY Mellon Investment Adviser, Inc., the SEC announcedcharges in a settled matter against an investment adviser for making material misstatements and omissions about the consideration of ESG principles to make investment decisions for some of its mutual funds and separately managed accounts. According to the Commission’s settled order, from July 2018 to September 2021 the adviser represented or implied in various statements that all investments in these funds had undergone an ESG quality review, even though that was not always the case. The settled order states that numerous investments held by certain funds had not undergone an ESG quality review at the time of investment.

Before you invest in an ESG fund

✓Carefullyread all of the fund's available information, including its prospectus and most recent shareholder report. You can get this information by looking at the fund’s filings on the SEC’s EDGAR database, from your investment professional, or directly from the fund.

✓ Understand the fees and expenses you will pay for the fund, and compare them to other investment options.

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✓Be sure that the fund’s investment strategy is consistent with your goals.

✓ Ask Questions:

  • Is ESG a core component of the investment selection process, or is it one of many factors that are considered to select investments?
  • To what extent does the fund focus on ESG factors versus more traditional factors?
  • How does the fund weight each of the three ESG factors within its ESG portfolio holdings?
  • What specific criteria within a factor does the fund use when determining its portfolio holdings?
  • How do the fund’s fees and expenses compare to other investment options?
  • What types of investments do you expect or desire the fund to be invested in, and what types of investments do you expect or desire the fund NOT to be invested in? Compare those expectations with published fund holdings to better understand whether the fund’s investment strategy is consistent with your preferences.
  • How does the fund explain and discuss its ESG practices, and how do those practices affect the performance and risk of the fund?
  • Is the fund employing an ESG practice that is of importance to you, such as voting proxies in a certain manner or engaging with issuers to influence their ESG practices?

Additional Resources

Mutual Funds and ETFs - A Guide for Investors

Five Questions to Ask Before You Invest

(Video) Why ESG Is the Biggest Scam of the 21st Century | Vivek Ramaswamy | Ep 151

This Investor Bulletin represents the views of the staff of the Office of Investor Education and Advocacy. It is not a rule, regulation, or statement of the Securities and Exchange Commission (“Commission”). The Commission has neither approved nor disapproved its content. This bulletin, like all staff statements, has no legal force or effect: it does not alter or amend applicable law, and it creates no new or additional obligations for any person.

FAQs

Do investors actually care about ESG? ›

The importance of ESG (Environmental, Social, Governance) continues to grow and has become a key area of focus for a range of stakeholders, particularly investors as they acknowledge that environmental and social issues present some of the decade's most difficult challenges.

How do I check my ESG score? ›

There are a few different places you can check to find your score. If you hold an account at a major financial firm such as Merrill Lynch, your personal ESG score will be listed on your account with your other personal details. You can also check any of the main ESG monitoring companies' websites.

Does the SEC require ESG disclosure? ›

Currently, the SEC does not require extensive line-item disclosure of ESG matters. All that may soon change, as the proposal calls for ESG reporting that goes well beyond current mandates. To date, companies have largely relied on 2010 guidance, with disclosures based on materiality.

What is one limitation of the ESG label? ›

Some of the challenges are as follows: Not all ESG factors are easily quantifiable, and such factors may not directly translate into earnings growth or enhanced performance for the firm. Current corporate sustainability disclosures are heavily skewed towards process and procedures and not towards actual performance.

Why is Elon Musk against ESG? ›

Effectively Musk is confusing ESG with sustainability and impact. The problem with Musk's claims is that ESG is not about impact: but operations. It's a lens through which to better understand how world events might risk a company's enterprise value, not how a company might pose risks to the world.

Does ESG really matter and why? ›

Even when ESG can be measured, there is no meaningful relationship with financial performance. Accordingly, the responses to ESG critics coalesce on three critical points: the acute reality of externalities, the early success of some organizations, and the improvement of ESG measurements over time.

Do ESG scores matter? ›

Companies that score well on ESG metrics are believed to better anticipate future risks and opportunities, be more disposed to longer-term strategic thinking, and focused on long-term value creation. With investors using ESG scores in their investment strategies, the consequences of a poor rating can be significant.

What is considered a good ESG score? ›

Some ESG ratings (or ESG scores) methodologies give a range from 0-100, with 70 and above considered a “good” ESG rating and 50 and below considered a “bad” rating. But others use a letter-based scoring mechanism—C (or CCC) being the worst and AAA being the best.

Which company has the best ESG score? ›

Best ESG Companies, Stocks
RankCompanyESG Score
1Worthington Industries75.82
2J.B. Hunt Transport Services73.09
3Verisk Analytics72.79
4Texas Instruments72.63
25 more rows
24 Oct 2022

Is ESG legally required? ›

Last March, the Securities and Exchange Commission (SEC) announced new environmental, social, and governance (ESG) disclosure requirements for companies. Under these new rules, public companies must enhance and standardize climate-related disclosures.

Is ESG disclosure mandatory? ›

Today, ESG reporting is largely not mandatory in the US, but that is changing. In March 2022, the US Securities and Exchange Commission (SEC) proposed climate-risk disclosure requirements, which would expand the annual reporting requirements of publicly traded companies.

Is ESG compliance mandatory? ›

ESG Reporting after the implementation of new norms has been stipulated mandatory for the financial year 2022-23 but was voluntary for the financial year 2021-22 so that businesses get sufficient to get used to new reporting regulations.

Why is ESG criticized? ›

It Confuses Investors:

ESG ratings, in turn, are built on comparative rankings of industry peers not on universal standards. This is why fossil fuel companies can have better ESG ratings than makers of electric vehicles. In addition, the data underlying ESG ratings are incomplete, mostly unaudited, and often dated.

Why is ESG reporting difficult? ›

It's the risks that you don't know about that will be the problem, and you cannot do that without a data-driven and tech-enabled risk management approach.” ESG risks are especially challenging to monitor because many aren't quantifiable. They can't be defined in terms of dollars and cents.

Why is ESG controversial? ›

These controversies could include toxic waste spills (environmental), human rights violations (social), or corrupt CEOs (governance). Unlike traditional financial information, ESG data is often unstructured and sourced from companies' self-reported data and news articles.

Is ESG really sustainable? ›

ESG metrics are a measure of how a company manages the risks of environmental, social and governance issues. The risks to its business and shareholders, not the risks the business creates for the outside world, to people and planet. ESG has become synonymous with the concept of sustainability.

Is ESG the future of investing? ›

ESG investing is a fast growing sector of finance, and, according to Bloomberg Intelligence, global ESG assets are likely to surpass $41 trillion in 2022 and $50 trillion by 2025. ESG is now an essential component in every corporate strategy from a risk mitigation and opportunity optimization standpoint.

Why Tesla was kicked out ESG? ›

In a blog post Wednesday, the S&P explained why it kicked Tesla out of its ESG index earlier this month. It said that Tesla's "lack of a low-carbon strategy" and "codes of business conduct," along with racism and poor working conditions reported at Tesla's factory in Fremont, California, affected the score.

Why is ESG good for investors? ›

Businesses with good ESG practices score higher in terms of reputation and carry less risk as they incorporate sustainability as their core value. Moreover, ESG analysis can help investors determine a business' long-term sustainability and any intangible ESG risks arising from these matters.

Why is ESG such a big deal? ›

The idea was that incorporating ESG data would help protect investments by avoiding material financial risks from things such as climate change; worker disputes and humans rights issues in supply chains; and poor corporate governance and resulting litigation.

Why is ESG important to regular investors? ›

According to Smith, ESG investing assumes that there are certain environmental, social and corporate governance factors that impact a company's overall performance. By considering ESG factors, investors get a more holistic view of the companies they back, which can help mitigate risk and identify opportunities.

What does an ESG score really say about a company? ›

ESG scores are based on environmental, social, and governance factors and assess issues such as energy use, employee satisfaction, business ethics standards, and executive pay. Environmental issues include can include factors such as: Carbon emissions. Climate change vulnerability.

What is the most important factor in ESG? ›

Governance is considered the “most important” element in relation to discussions about ESG, according to Architas.

Are ESG funds worth it? ›

The research showed that overall, sustainable funds have consistently shown a lower downside risk than traditional funds. And while some ESG funds are relatively new (particularly many passive ones), they've been able to show solid performance and resiliency in both good markets and bad.

How do you get a high ESG score? ›

Six steps to improve your ESG performance
  1. Integrate ESG into your business strategy. ...
  2. Identify your material topics. ...
  3. Understand your ESG ratings. ...
  4. Align to global & regulatory frameworks. ...
  5. Strive for 'investment grade' data. ...
  6. Consider your communication channel.

What is the lowest ESG score? ›

Examples of ESG scores

Sustainalytics analyzes over 14,000 public companies and assigns them a risk rating of 0-40, with 40 being the highest risk (and lowest possible rating.)

Who are the largest ESG investors? ›

Ten Largest ESG Funds and Their Performance
RankNameAUM $m
1Morgan Stanley Institutional Fund – Global Opportunity Portfolio (MGGPX)3,846
2Brown Advisory Sustainable Growth Fund (BIAWX)2,086
3Morgan Stanley Institutional Fund – International Opportunity Portfolio (MIOPX)1,761
4Calvert Equity Fund (CSIEX)3,766
5 more rows

What are some examples of ESG investing? ›

ESG factors are used to evaluate companies and stocks in those key areas.
...
ESG investing examples
  • 1919 Socially Responsive Balanced A (SSIAX)
  • Pax Large Cap Fund Institutional (PXLIX)
  • Thornburg Better World International I (TBWIX)
  • Parnassus Core Equity Investor (PRBLX)
  • iShares MSCI USA ESG Select ETF (SUSA)
7 Nov 2022

What are some examples of ESG? ›

Key ESG Factors
  • Environmental. Conservation of the natural world. - Climate change and carbon emissions. - Air and water pollution. ...
  • Social. Consideration of people & relationships. - Customer satisfaction. - Data protection and privacy. ...
  • Governance. Standards for running a company. - Board composition. - Audit committee structure.

Is ESG outdated? ›

The concept of ESG scores – aggregating hundreds of indicators from diverse and complex topics – is outdated, particularly when repackaged by the investment management industry as an investment signal.

What are the 3 essential pillars of ESG? ›

The three pillars of ESG are:
  • Environmental – this has to do with an organisation's impact on the planet.
  • Social – this has to do with the impact an organisation has on people, including staff and customers and the community.
  • Governance – this has to do with how an organisation is governed. Is it governed transparently?
14 Jul 2022

Do all companies have ESG? ›

More than 90 percent of S&P 500 companies now publish ESG reports in some form, as do approximately 70 percent of Russell 1000 companies. 1. Sustainability reporting in focus, G&A Institute, 2021. In a number of jurisdictions, reporting ESG elements is either mandatory or under active consideration.

Is ESG reporting mandatory for private companies? ›

Even if private companies aren't directly subject to a regulation, their public company customers might be. That means private companies need to report certain ESG information so their customers can comply with requirements.

Do public companies have to report ESG? ›

Compliance Risk

Most ESG reporting is voluntary – at least so far. While some companies do disclose information about climate risks, for instance, there is no global standard for how those risks are measured or reported. As a result, the facts can be inconsistent, subjective, and difficult to compare between companies.

Where is ESG mandatory? ›

At the end of June 2022, an ambitious agreement was reached by the European Parliament and the Council (EU Member States) to require the mandatory reporting on ESG by a considerable chunk of companies (incl. Large non-EU and subsidiaries) operating on the EU market.

What are the disadvantages of ESG? ›

The Downsides of ESG
  • Companies can get a passing grade even when you disagree with their policies. ESG investments ideally encourage companies to do better. ...
  • Ratings are not standardized. You may think ESG scores are based on how well the company benefits the world. ...
  • Fees can be higher, and diversification can be less.
14 Sept 2022

Does ESG apply to individuals? ›

Yes… with a few tweaks: just because you are not a business, that does not mean that the idea of measuring yourself against ESG standards cannot apply to your own life.

Why banks can no longer ignore ESG? ›

ESG as a Solution for Banking Corruption

Tracking ESG KPIs can provide a solution to major banks operating with integrity and harboring the trust of millions. By tracking these essential KPIs, banks can monitor all operations, and eventually report their efforts to the public, building further confidence in the system.

Is ESG just a fad? ›

ESG investing is more than just a passing fad, it has become a mainstream investing strategy. ESG mutual funds are one way to do this, individual stocks adhering to ESG principles are another.

What are main ESG issues? ›

Environmental issues may include corporate climate policies, energy use, waste, pollution, natural resource conservation, and treatment of animals. ESG considerations can also help evaluate any environmental risks a company might face and how the company is managing those risks.

Is ESG A risk or Opportunity? ›

ESG factors can often fit into an existing enterprise risk management framework. Each of the environmental, social and governance spheres has its own distinct risks and business opportunities; once these risks and opportunities have been identified, they can be monitored and addressed.

Is the ESG exam hard? ›

Just like Investment Management Certificate and Certificate in Climate and Investing (CCI), the Certificate in ESG Investing is a Level 4 qualification, which means that the level of difficulty of the qualification broadly equates to the first-year of an undergraduate degree.

What is the main concern about ESG reporting at the moment? ›

Some of the major concerns that organizations need to address with respect to sustainability reporting include regulations and procedures governing the involvement of finance, audit committees and board of directors; current climate-related data being collected and the associated level of assurance; process for ...

What are good ESG questions? ›

10 ESG Questions Companies Need to Answer
  • Is ESG undermining your company's competitiveness? ...
  • Does driving the ESG agenda mean sacrificing company returns? ...
  • How are you navigating ESG trade-offs? ...
  • How does ESG change due diligence? ...
  • Should you become a public benefit corporation?
3 Jan 2022

Is ESG The new sustainability? ›

ESG is based on standards set by lawmakers, investors, and ESG reporting organizations (e.g., GRI, TCFD, MSCI), whereas sustainability standards — while also set by standards groups like GHG Protocol — are more science-based and standardized.

Is ESG replacing CSR? ›

But these shifts have led to an increased focus on ESG (environmental, social, and governance) and CSR (corporate social responsibility) reporting. You might be wondering is CSR the same as ESG? The abrupt answer is, no. Still, these terms are covered under the same sustainability umbrella.

Why do investors care about ESG? ›

ESG analysis can provide valuable insights about factors that can have a significant impact on the financial metrics of a company and therefore better inform our investment decisions.

Do companies care about ESG? ›

Much like investors are paying more attention to ESG, many companies are looking for supply chain partners that embrace sustainability efforts. For example, many retail stores are making decisions not to stock products made by companies considered to have poor ESG performance.

What investors Think ESG is about? ›

Nearly a quarter of survey respondents thought ESG stands for "earnings, stock, growth," not environmental, social, and governance factors.

What percent of investors want ESG? ›

“I think impact investing is another step on from ESG,” says a portfolio manager at a UK wealth management company. ESG integration, cited by almost six in 10 (59%) global investors, remains the most used implementation strategy.

What is the problem with ESG investing? ›

ESG funds typically charge fees 40 percent higher than traditional funds making them a timely answer to asset management margin compression. All too often these higher fees are unwarranted given that ESG funds often closely mirror “vanilla” funds.

Who are the biggest investors in ESG? ›

Ten Largest ESG Funds and Their Performance
RankNameAUM $m
1Morgan Stanley Institutional Fund – Global Opportunity Portfolio (MGGPX)3,846
2Brown Advisory Sustainable Growth Fund (BIAWX)2,086
3Morgan Stanley Institutional Fund – International Opportunity Portfolio (MIOPX)1,761
4Calvert Equity Fund (CSIEX)3,766
5 more rows

What Elon Musk said about ESG? ›

ESG is a scam,” Musk said in response, claiming that the ratings agency “lost their integrity.”

Videos

1. Under-represented and undervalued? - The ESG & Tech Show | VectorVest
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2. The Future of Environmental, Social, and Governance (ESG) Investing
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3. ISS Governance Bulletin Analyst Insights: Special Situations in Full Force Post-Pandemic
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4. ESG Investment Process Compliance
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5. Aligning Investment Objectives and ESG Values
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6. ISS ESG New Horizons – Navigating ESG Globally in 2022
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