Environmental, Social, and Governance (ESG) mutual funds
ESG mutual funds give investors a way to invest in companies that align with the issues that are important to them. Some of these funds may offer a way to exclude companies that don't align with investors' values. These mutual funds are often defined by their environmental, social, or corporate governance-focused investing strategy.
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What is ESG?
Environmental, Social, and Governance (ESG) is the umbrella term Schwab uses to describe various investing approaches that focus on social, environmental or corporate governance factors rather than solely risk and return.
The financial industry uses many different terms to describe these approaches to investing, and ESG has become one of the most widely used. When we refer to ESG, we mean it to encompass investing approaches that specifically use the term ESG, but also those described as "values-based investing," "impact investing," "sustainable investing," and other approaches.
Common approaches to ESG include:
- Values-based investing, also called negative screening, which focuses on excluding companies from the portfolio. This approach appeals most strongly to investors who care about avoiding investments in companies that don't align with their values.
- Integration, which attempts to improve the risk/return profile by considering environmental, social, and governance (ESG) risks in the investment process. In this approach, portfolios are constructed by selecting companies that score well on material ESG issues that are important for those companies' sector.
- Impact investing, which refers to explicitly deploying investment dollars in an effort to directly achieve a desired outcome. Impact investors are typically more concerned with making a difference in the world or environment through the companies they invest in.
How do you incorporate an ESG mutual fund into your portfolio?
For investors who care strongly about ESG issues, these funds can be an attractive investment. As you should with non-ESG investments, you should consider the quality of the mutual fund—its costs, risks, performance potential, and the experience of the investment team. Then you should consider how the vehicle's stated objective and strategy aligns with your ESG preferences by further examining the mutual fund's holdings.
View a list of ESG funds available at Schwab.
What are the pros and cons of ESG mutual funds?
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Pros
Convenience
One investment can give you cost-effective exposure to dozens—or even hundreds or thousands—of individual securities. Investors can also eliminate much of the research, buying, and tracking of securities, as mutual funds are professionally managed.Reduced risk potential
ESG investing may reduce the risk of owning companies that show up in the headlines for environmental catastrophes, fraudulent behavior, etc. While the overall investment risk for ESG portfolios is similar to non-ESG, ESG-focused funds try to avoid companies with poor governance and high environmental risk. -
Cons
Greenwashing
As the investing public has grown more interested in ESG, some portfolio managers have begun to talk about ESG aspects of funds that formerly were not described in those terms. In some cases, the degree of ESG focus in the fund is minimal and describing such funds as ESG is known as "greenwashing." Signs that indicate an ESG fund may be greenwashed include:- Very weak references to ESG factors in the fund's investment objective and description.
- A fund that had no references to ESG in recent years suddenly adding in ESG terminology to the fund documentation or prospectus.
What factors can I consider when choosing an ESG mutual fund?
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