By Debbie Carlson
As data quality improves, Vanguard thinks about its next steps
Vanguard isn’t known for its broad suite of environmental, social and governance investment funds. It has just five available in the U.S., versus dozens at rival Blackrock and other firms.
But as billions of dollars have flowed into rival firms’ ESG products in the past year and a half, the fund giant may be shifting its stance as it adds expertise in the area.
Kaitlyn Caughlin, who oversees the firm’s product review, wouldn’t say whether or when to expect new products, but noted the firm is doing “a lot of additional research right now.”
The firm recently created an ESG product category team in the U.S. 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, though not solely, dedicated to ESG. Those teams will collaborate with others in Vanguard, both related to ESG product and ESG integration in conventional products.
The hiring shows Vanguard is expanding into the space, but it may be more dipping in its toe rather than fully embracing it, even as ESG is one of the hottest investing trends. After all, Vanguard, with $7.2 trillion in assets under management as of Jan. 31, has less staffing than other, smaller mainstream firms, let alone ESG powerhouse fund families such as Calvert or Parnassus.
Vanguard lags smaller mainstream firms in attracting ESG money and in staffing. For example, Invesco (IVZ) is less than one-fifth the size (link) of Vanguard by total assets under management, at $1.35 trillion as of Dec. 31, 2020, but it has 17 ESG ETFs and mutual funds in North America. Its largest, Invesco Solar ETF (TAN), at $3.6 billion as of Dec. 31, is the fifth-largest ESG fund in the U.S. and was ahead of Vanguard’s biggest ESG ETF, Vanguard ESG U.S. Stock ETF (ESGV), at $2.9 billion, as of Dec. 31.
Invesco has 13 people on its global ESG team, and Glen Yelton, head of Americas ESG at Invesco, says it is hiring five or six more people.
BlackRock (BLK), which has $8.7 trillion in AUM as of Dec. 31, and owns the iShares brand of ETFs, has 10 U.S. equity and fixed-income indexed ESG ETFs (link).
There’s plenty of money to fight for. US SIF, an organization that’s tracked sustainable investment since 1995, reported (link) late in 2020 that 33% money professionally managed in the U.S. is invested sustainably, at $17 trillion out of $54 trillion. Sustainable investing covers a wide swath of investing to consider both financial return and social and environmental good, and ESG investing is the largest part of sustainable investing.
ESG was growing steadily for years, but really took off beginning in late 2019. The biggest ESG ETF by assets under management — iShares ESG Aware MSCI USA ETF (ESGU) — had $13.4 billion at the end of 2020. Back in August 2019, it held only $286 million and surpassed $1 billion (link) by the end of 2019, according to ETF Research Center.
Invesco’s 12-year-old Solar ETF saw assets move north of $500 million in mid-2020 and then began to snowball (link). Vanguard’s ESG U.S. Stock ETF hit $500 million by mid-2019 and is now four times that size.
While ESG funds can be launched as traditional mutual funds or ESG funds, most new ESG funds are ETFs.
Vanguard mostly uses exclusionary ESG screens
Better ESG data could change what funds Vanguard launches in the future. Of Vanguard’s five U.S.-based ESG exchange-traded funds and mutual funds, four are index-based and use exclusionary screens to weed out undesirable sectors, such as tobacco.
But just using exclusionary screens is ESG 1.0, as many ESG funds also have inclusionary screens, specifically picking stocks or sectors to include in their holdings, based on the fund’s mission.
“One of the reasons why we haven’t launched an inclusionary-based index strategy yet is because we just haven’t felt like the disclosures have been consistent or high-quality enough yet,” Caughlin says.
In a December report about fund firms’ ESG commitment levels, Morningstar gave Vanguard its bottom ranking of low, noting “ESG passive strategies do not differentiate the funds from their broader universes as much as peers that explicitly integrate ESG criteria to select companies with positive ESG characteristics.”
Aside from ESG U.S. Stock ETF, Vanguard’s other exclusionary index-based funds are ESG International Stock ETF (VSGX), ESG U.S. Corporate Bond ETF (VCEB) and the Vanguard FTSE Social Index Fund , a mutual fund. The fifth fund, a mutual fund by sub-advisor Wellington called the Global ESG Stock Fund , integrates exclusionary and inclusionary screens and is actively managed.
Vanguard’s index funds use many of the common exclusionary environmental and social screens, including screening out companies in controversial industries such as tobacco, alcohol, adult entertainment, fossil fuels, nuclear power and weapons, in addition to firms that don’t take steps to promote diversity. Those common exclusionary screens have no governance filters.
Those exclusionary screens don’t always filter out what investors think they might. For example, despite having a fossil-fuels screen (link), ESG U.S. Stock ETF has $23.1 million, or 0.78% of assets, in fossil-fuel companies according to fund screener site As You Sow. That’s not uncommon (link) for index ETFs that want exposure to mimic the broader stock index.
‘Never going to slice and dice’ every which way
Although Vanguard’s FTSE Social Index Fund dates back to 2003, it didn’t release its next ESG funds, ESG U.S. Stock ETF and ESG International Stock ETF, until 2018. But launching a lot of products is not what Vanguard does, Caughlin says.
“Our approach is never going to be to slice-and-dice and meet every single investor’s different way they want to do it,” she says. “But we do want to be able to allow our investors who care about being able to express their preferences, or values and being able to build portfolios that are going to deliver really great long-term investor outcomes that are here to stay.”
There are no U.S. or global standards about how companies release ESG data or what data they do release. The Sustainability Accounting Standards Board created (link) a set of industry standards a while back, and industry efforts over the past year, such as from Investment Company Institute (link), and the CFA Institute (link) seek to get more disclosure from companies and funds.
Sustainability is also getting greater attention from the part of regulators, too. All of those reasons are why Vanguard is doing more research into ESG strategies to see how it fits into the fund firm’s framework, which Caughlin says centers around enduring investment themes.
“We’re definitely evaluating a number of different funds right now. So I don’t by any means feel like our work is done in ESG. But we are not going to launch anything for ESG just like we do for any of our other new product development without it hitting our very high bar,” she says.
How Vanguard ESG funds perform
Performance for the FTSE Social Index Fund, which seeks to track the performance of the FTSE4Good US Select Index, has $11.3 billion in assets and a strong 10-year track record of a 14.6% annualized return, beating the benchmark Russell 1000 index (think the S&P 500 index and then another 500 companies) . The much younger ESG U.S. Stock ETF is up 36% on a one-year annualized basis, beating the Russell 1000, and slightly outperforming BlackRock’s iShare ESG Aware MSCI USA ETF(ESGU), which is up 34% on a one-year annualized basis .
Vanguard considers the Wellington-advised Global ESG Stock Fund, which seeks out companies with high financial productivity and strong governance, to be an inclusionary fund. Morningstar flagged that fund in its report, saying “integrated ESG approaches at Vanguard are more recent and show some promise.”
It is up 46.5% on a one-year basis, outperforming the MSCI ACWI Large Cap index, its benchmark.
Caughlin hinted that investors may see more products like the Wellington fund. The flip side for investors may be higher fees than they are used to seeing from Vanguard. The U.S. Stock ETF has an expense ratio of 0.12%. The Wellington fund has an expense ratio of 0.58%. Yet Morningstar says that is low for a no-load world stock fund, which normally is around 1.05%.
“Right now, given where we’re at with disclosures, I could see us looking for more very talented active managers who can both provide outperformance above a bit of benchmark while incorporating ESG best practices into their company selection,” she says.
Debbie Carlson is a MarketWatch columnist. Follow her on Twitter @DebbieCarlson1 (link).
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