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Investing Specialists

ESG ETF Bucket Portfolios for Retirees

These in-retirement portfolios invest in ESG-friendly ETFs that should provide marketlike exposures.

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Sustainable mutual funds--also called ESG (environmental, social, governance) funds--have been soaring in number and popularity in recent years. The number of sustainable funds and ETFs available to U.S. investors jumped by 30% in 2020, and ESG-oriented funds and ETFs took in more than $50 billion in new assets in the U.S. last year, too. 

Mirroring a trend in the broader mutual fund universe, passively managed ESG funds are growing in number, too. Those developments mean that it’s now fairly simple to create a well-diversified, low-cost portfolio consisting of securities with good ESG attributes. 

I’ve created four suites of ESG portfolios: ETF portfolios geared toward retirees as well as retirement savers, and traditional mutual fund portfolios created toward those same groups. As with the other model portfolios, I relied on Morningstar’s Lifetime Allocation Indexes to help set the portfolios’ asset-class exposures; the Bucket approach further informs the portfolios' positioning. To help select securities for the portfolios, I relied on input from Jon Hale, Morningstar's director of sustainability research for the Americas, and Morningstar’s passive-strategies researchers. 

Aggressive ESG ETF Bucket Portfolio

Bucket 1: Years 1-2
8%: Cash (money market funds and accounts, CDs, checking and savings accounts, and so forth; specific percentages will vary based on the amount of assets and the retiree's spending rate)

This portion of the portfolio is here to supply living expenses on an ongoing basis. As such, we're not taking any chances with it but instead parking it in true cash instruments. The specific percentage of the portfolio that Bucket 1 consumes will depend on both the retiree's portfolio size as well as his or her spending rate. For example, a retiree with a $500,000 portfolio spending $15,000 a year would park 6% of his or her portfolio in Bucket 1 ($15,000 times 2, divided by $500,000). The retiree spends out of Bucket 1, then refills it as it becomes depleted. 

For investors who would like to "ESG" this portion of their portfolios, there are a few options. One is BlackRock Liquid Environmentally Aware Fund (LEFXX), a money market mutual fund geared toward investing in companies and counterparties with good environmental practices. Additionally, BlackRock buys carbon offsets with 5% of revenues from the fund, then makes an additional contribution annually to the World Wildlife Fund.

Bucket 2: Years 3-10
7%: iShares ESG 1-5 Year USD Corporate Bond ETF (SUSB)
7%: iShares TIPS Bond ETF (TIP)
18%: iShares ESG U.S. Aggregate Bond ETF (EAGG)

For Bucket 2, anchored in high-quality fixed-income investments, I used EAGG to provide core exposure; it should deliver performance that closely resembles its “parent” index, in this case the Bloomberg Barclays U.S. Aggregate Bond Index, with an emphasis on ESG characteristics.

Beyond that core exposure, ESG bond options are sparse. For short-term exposure, I relied on iShares ESG 1-5 Year USD Corporate Bond ETF. However, an investor who isn’t comfortable with the credit risk inherent in a corporate-bond-heavy fund like that one could reasonably use a short-term U.S. government-bond fund such as iShares Short Treasury Bond ETF (SHV) or Vanguard Short-Term Treasury ETF (VGSH). After all, U.S. government bonds figure prominently in most core ESG bond funds, so an ESG investor could reasonably focus her fixed-income exposure, or a portion of it, on such bonds. Using that same logic, I used iShares TIPS Bond TIP to provide inflation protection. (Treasury Inflation-Protected Securities are not a component of Bloomberg Barclays Aggregate indexes.)

Bucket 3: Years 11 and Beyond
37%: iShares ESG MSCI USA (ESGU)
5%: iShares ESG MSCI USA Small-Cap ETF (ESML)
15%: iShares ESG MSCI EAFE ETF (ESGD)
3%: iShares ESG MSCI Emerging Markets ETF (ESGE)

For Bucket 3 of the portfolio, which is a globally diversified equity basket designed to supply the portfolio with long-term growth, I relied on iShares ESG funds. These ETFs all track ESG indexes crafted by MSCI. Note that these ETFs were all designed to track their non-ESG index counterparts fairly closely: For example, iShares ESG MSCI Emerging Markets ETF is designed to closely track the MSCI Emerging Markets Index. 

Moderate ESG ETF Bucket Portfolio

Bucket 1: Years 1-2
10%: Cash

Bucket 2: Years 3-10
10%: iShares ESG 1-5 Year USD Corporate Bond ETF 
10%: iShares TIPS Bond ETF
20%: iShares ESG U.S. Aggregate Bond ETF

Bucket 3: Years 11 and Beyond 
30%: iShares ESG MSCI USA 
5%: iShares ESG MSCI USA Small-Cap ETF 
12%: iShares ESG MSCI EAFE ETF
3%: iShares ESG MSCI Emerging Markets ETF

Conservative ESG ETF Bucket Portfolio
Bucket 1: Years 1-2
12%: Cash

Bucket 2: Years 3-10
13%: iShares ESG 1-5 Year USD Corporate Bond ETF 
15%: iShares TIPS Bond ETF 
20%: iShares ESG U.S. Aggregate Bond ETF

Bucket 3: Years 11 and Beyond 
20%: iShares ESG MSCI USA
4%: iShares ESG MSCI USA Small-Cap ETF 
14%: iShares ESG MSCI EAFE ETF 
2%: iShares ESG MSCI Emerging Markets ETF

How to Use the Portfolios
In keeping with the Bucket approach to retirement allocation, the portfolios all include cash stakes. The goal is to supply funds for living expenses so that the retiree won’t need to sell any long-term assets--either bonds or stocks--to meet living expenses in a period of weakness for the asset class. Yet how much cash to hold--and how much to hold in bonds and stocks--depends completely on the retiree and his or her approach to portfolio withdrawals. A new retiree who’s using the 4% guideline for withdrawals might reasonably hold 8% of her portfolio in cash (two years’ worth of 4% withdrawals). A retiree whose pension is meeting most of his living expenses could reasonably employ a much lower cash position and hold much more in stocks, largely because his ongoing portfolio withdrawals are apt to be modest. Ideally, retirees employing a Bucket approach would use those portfolio withdrawals to back into a sensible mix of cash (Bucket 1), high-quality bonds (Bucket 2), and stocks (Bucket 3).

Note that I have developed these portfolios for use with tax-deferred accounts rather than taxable assets. While the equity components of the portfolios all consist of ETFs and are apt to be reasonably tax-efficient, their fixed-income stakes consist of taxable bonds. That means that for investors in taxable accounts who are also in high tax brackets, a sizable share of the total return they receive from their bond holdings will be taxed as ordinary income tax. To date, there are only a handful of municipal-bond funds that are managed with an explicit focus on bonds with strong ESG attributes. However, as interest in ESG investing grows, I would expect to see ETFs launched to meet the need.

Christine Benz does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.