Climate change. Workers’ rights. Diversity and inclusion. The range of environmental, social and governance (ESG) issues that investors may want to address is extensive and growing.
The different reasons investors may have for incorporating ESG considerations are equally diverse. You may want to exclude certain businesses activities or sectors because they don’t align with your personal preferences; or you may be looking for a financial return, for example by investing in renewable energy companies that will benefit from the transition to a low-carbon economy.
And many of you will have a mix of views.
At Vanguard, our belief is that ESG factors can affect a company’s performance over the long term, whether positively or negatively. And addressing material ESG matters is integral to our goal of delivering long-term value for our investors and giving them the best chance of investment success.
Our aim is to offer different options because we know there are no easy answers. As a result, the extent to which our funds consider ESG factors varies according to the type of fund you invest in.
There are four types of fund you can invest in with Vanguard in the UK:
1. Index funds
2. Active funds
3. ESG index funds
4. ESG active funds
Each type considers ESG questions differently. The approach that matches most closely with your preferences will be unique to you. It’s your choice.
Here is some further information about each type of fund.
Firstly, most of our funds consider ESG factors to some extent. This includes our index funds and exchange-traded funds (ETFs) and our range of multi-asset funds which use our index funds as their building blocks.
Through our investment stewardship teams around the world, we engage with the companies owned by Vanguard’s equity index funds, meeting with company directors regularly to discuss the material business risks, including ESG risks, they may face and to understand how companies are addressing these risks, where appropriate. The funds also vote at shareholder meetings to support good company governance practices.
Since our index funds and ETFs are fully diversified across entire markets, they are invested across all types of companies – some may be more exposed to environmental and social risks than others.
Investors, nonetheless, get the benefits of our stewardship efforts as well as the market return.
Our actively managed funds necessarily take a different approach because, unlike index funds, they have the flexibility to choose the companies they invest in and may assess a company’s ESG risks on a case-by-case basis.
Here, ESG factors may be integrated into their investment decisions, alongside other financial considerations. This careful analysis gives them a more complete picture of a company’s risks and opportunities in their efforts to beat the market return.
Our active managers may also use their engagements with the companies they own to inform their investment and voting decisions.
ESG index funds
For investors who want a fund with a specific ESG mandate and want to remove or reduce their exposure to companies involved in certain business activities, we also offer a range of broadly diversified and transparent exclusionary index funds. These funds aim to offer broad diversification at low cost.
They track indices that screen out certain business activities or sectors, including companies involved in the manufacture or supply of fossil fuels, tobacco and controversial weapons. The exclusions are consistently applied across the entire index series1.
ESG active funds
Our final category of fund is our actively managed ESG range, which includes a suite of multi-asset funds with a targeted allocation to both shares and bonds, as well as a sustainable fund with a 100% allocation to shares.
These funds allocate capital to companies based on specific sustainability criteria and are designed for investors who want to generate long-term growth from their investments, alongside an emphasis on certain ESG considerations2.
How does ESG investing impact performance?
Our research3 has shown that the performance of many ESG funds differs, historically, from that of the broader market. However, these differences have often varied from fund to fund, as have their drivers. What's more, for the vast majority of these funds, we have found that the factors driving these differences can also be applied to traditional, non-ESG funds.
Remember, the most important consideration in selecting an approach is unique to you, the investor. The choice is yours.
One thing we are clear about though: the tenets of diversification and low cost should not be sacrificed when building a portfolio that best matches your preferences.
The following diagram summarises the ESG options available to you at Vanguard:
1 Companies are screened for both primary (e.g., producer/ manufacturer) and secondary (e.g., retailer/ supplier) involvement in the exclusion categories using revenue thresholds. The exceptions are cannabis and fossil fuels, which are screened only for primary involvement. There are three levels of restriction—least, moderate and most restrictive—based on different revenue thresholds.
2 The fund managers incorporate sustainability considerations in four main ways: Net zero commitment (a 2050 net zero target aligned to the Paris Agreement); ESG risk avoidance (a clear set of exclusions); engagement with portfolio companies (on ESG matters and to promote net zero targets); and good governance assessment (the companies in which the fund invests must follow good governance practices as a precondition for investment).
3 Originally published in the Journal of Portfolio Management: Plagge, J.-C. and D. M. Grim. 2020. ’Have Investors Paid a Performance Price? Examining the Behavior of ESG Equity Funds.’ JPM Vol 46 Issue 3 Ethical Investing: 123–140. Performance of US index and active equity mutual funds and ETFs that indicate the use of ESG factors, as determined by Morningstar. Time period observed: 1 January 2004 - 31 December 2018. The original research was conducted in 2019 and was then updated with data to the end of 2021.
Investment risk information
The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.
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