Finding the Right ESG Funds for Your Portfolio, Part 2

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A lot of ink has been spilled lately on the subject of greenwashing, which involves the use of false or misleading claims about how environmentally sound or socially responsible a sustainable fund's investments are. Much of the alarm relates to misconceptions about what exactly a fund is invested in, and the need to pick the right one for you.

To help investors wary of greenwashing, we recently recommended familiarizing yourself with Morningstar's Sustainable Investing Framework to help clear up any misunderstandings you may have. Doing so might help you avoid situations where you feel disappointed or even cheated when you learn that some of the sustainable investments you've made aren't delivering the benefits you thought they promised.

How do you identify the best fund for you? It depends on the approach you want to take—as sustainable investing describes a wide array of approaches. Three of the most common strategies are practicing active ownership, targeting sustainability themes, and assessing impact. (In our earlier piece, we looked at three other strategies: applying exclusions, limiting environmental, social and governance risk, and seeking ESG opportunities.)

Sustainable Investment Funds That Practice Active Ownership

This refers to the practice of seeking positive outcomes by doing things owners do, such as voting proxies, proposing shareholder resolutions to the company's board about actions they might take to improve shareholder value, and participating in ESG-related investor coalitions. You'll see more and more examples of this in the springtime, when proxy voting takes place during annual company meetings.

Here's how it works. Trillium Asset Management runs Trillium ESG Small/Mid Cap Fund TSMDX. It's extremely active in urging corporate managements to improve their behavior. Recently, a majority of Apple shareholders supported Trillium's proposal for the technology company to analyze the civil rights impact of its practices on workers and other stakeholders, after reports of racial and other forms of harassment had occurred.

The audit helps Apple “identify their blind spots and do a more comprehensive job of bringing in stakeholder concerns and making sure they’re doing the right things,” Trillium's chief advocacy officer Jonas Kron says. “It’s like fixing the roof of your house--it makes sure the integrity of your home is maintained.”

Funds That Target Sustainability Themes

Targeting sustainability means identifying investments that stand to benefit from the long-term trend toward greater sustainability in the way we live and work. One example is climate funds, such as GMO Climate Change III GCCHX, New Alternatives NALFX, and SPDR Kensho Clean Power ETF CNRG. (You can read more here about investing in climate funds.)

Another is investing in gender-lens funds, which specialize in companies growing female leadership, or with a focus on metrics like equal pay for women, such as the Pax Ellevate Global Women's Leadership Fund PXWEX or the Impact Shares YWCA Women's Empowerment ETF WOMN.

Using Sustainable Funds to Assess Impact

Increasingly, you will also hear about the strategy of assessing impact, in which the fund chooses stocks and other securities based on how well they achieve certain outcomes that promote sustainability. Bond fund managers might look closely at what the proceeds of a debt sale are used for. Stock investors might consider if a company's products or services support the 17 United Nations Sustainable Development Goals, such as eliminating hunger and affordable clean energy, all of which aim to achieve a better future.

One such fund is Impact Shares Sustainable Development Goals Global Equity ETF SDGA, which tracks the Morningstar Societal Development index. It focuses on companies that are actively engaged in producing economic benefits in the 47 poorest countries. IShares MSCI Global Impact ETF SDG tracks an MSCI index focusing on companies that derive most of their revenue from products and services that address at least one of the world's major social and environmental challenges identified in the sustainable development goals.

Understand the Unique Goals of Each Sustainable Investment

Still other funds combine several approaches. For example, Domini Impact Equity Fund DSEFX invests in mid- to large-cap U.S. companies “that demonstrate peer-relative environmental and social leadership” as well as in “solution-oriented companies” that invest in themes, such as helping ensure access to clean water, and expanding financial inclusion.

Some of the loudest criticism of sustainable investing suggests that many individuals who want to have an impact are investing in funds that mainly seek to avoid ESG risk. Of course, greenwashing does exist. That's why it's important, more than anything, to know what you want to accomplish by investing sustainably.

“In the years I’ve been in this field, I've seen the term sustainable investing evolve into more of an umbrella concept that encompasses a number of different styles,” says Shila Wattamwar, global head of retail and wealth ESG strategy at Morningstar. That wide spectrum of approaches and funds lets investors diversify their asset allocation, she says.

“All of these styles still embody the concept of sustaining the world and building a more just and sustainable economy; and like always, different topics resonate more or less importance with different people,” Wattamwar says.

What are the Best Sustainable Funds?

Ultimately, the idea of the “best sustainable funds” comes down to your own goals: whether it's to avoid fossil fuels, invest in clean energy for the long term, or avoid controversial industries.

By taking the time to explore the different approaches to sustainable investing, you can find the right investments for your situation--and avoid feeling misled by funds’ different goals.