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ESG Mutual Fund Bucket Portfolios for Retirees

These portfolios are composed of mutual funds with strong ESG and investing track records.

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Younger investors may be most closely associated with wanting to invest in companies that align with their principles, but plenty of older adults are interested in doing so, too. With them in mind, I’ve created model “bucket” portfolios featuring exposure to environmental, social, and governance funds.

I’ve created portfolios composed of exchange-traded funds as well as this series, which features mutual funds. The ETF portfolios are designed to incorporate investments that pass muster on the ESG front but that generally have low “tracking error,” meaning that the portfolios’ performance is likely to hew closely to that of a portfolio consisting of plain-vanilla, non-ESG ETFs. With the mutual fund portfolios, I’ve incorporated mutual funds, mainly actively managed ones, with more ESG-forward strategies.

For example, the largest domestic-equity holding in the portfolios, Parnassus Core Equity (PRBLX), has long been a leader in the ESG investing space and applies rigorous ESG standards to each of the holdings that comes into the portfolio. Analyst Stephen Welch notes that in addition to excluding companies that derive significant revenue from alcohol, tobacco, weapons, nuclear power, or gambling, they seek companies with sustainable competitive advantages, increasingly relevant products or services, exemplary management, and ethical practices.

As with the other model portfolios, I relied on Morningstar’s Lifetime Allocation Indexes to help set the portfolios’ asset-class exposures. I worked with Jon Hale, Morningstar's director of sustainability research for the Americas, and Morningstar's manager research analysts to populate the portfolios with holdings with strong ESG credentials as well as investment acumen. Because the mutual fund portfolios encompass a heavier ESG emphasis, I would expect them to exhibit performance that differs more meaningfully from market benchmarks than the ETF portfolios. In particular, the portfolios tend to lean toward the growth side of the Morningstar Style Box, whereas the ETF portfolios are better balanced along the value-blend-growth spectrum. And because the mutual fund portfolios are anchored with active equity funds, their costs are obviously higher, too. I focused on funds that are widely available from major brokerage-firm platforms without a load or transaction fee. (There's one exception: Investors will need to pay a transaction fee to buy PIMCO Total Return ESG (PTSAX)--discussed below--on major brokerage platforms.) Investors who are seeking more indexlike performance and/or those who would like to lower their total costs can reasonably employ any number of fine core ESG index funds in lieu of the actively managed options featured here.

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 one 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 who's spending $15,000 a year would park 6% of his or her portfolio in bucket one ($15,000 times two, divided by $500,000). The retiree spends out of bucket one, then refills it as it becomes depleted. 

Cash investors who would like to make sure their holdings align with ESG principles might consider BlackRock Liquid Environmentally Aware Fund LEAF, a money market fund. Hale notes that this fairly new fund invests in companies and counterparties with good environmental practices and avoids those with poor ones. BlackRock uses 5% of the revenues from the fund to buy carbon offsets, then makes an additional contribution annually to the World Wildlife Fund.

Bucket 2: Years 3-10
7%: Vanguard Short-Term Federal (VSGBX)
7%: Vanguard Short-Term Inflation-Protected Securities (VTIPX)
18%: PIMCO Total Return ESG (PTSAX)

For core fixed-income exposure, I had originally employed TIAA-CREF Social Choice Bond (TSBRX), but that share class of the fund was recently downgraded to Neutral from Bronze. I've swapped in the Gold-rated PIMCO Total Return ESG in its place. That fund features the managerial strength and analytical resources that PIMCO's flagship enjoys, but with an ESG emphasis. The hitch is that retail investors buying the fund through a brokerage platform will need to pay a transaction fee to buy it. Investors who expect to trade more frequently would be better off with an ESG bond fund that doesn't entail such fees; iShares ESG U.S. Aggregate Bond Index (EAGG) is a solid option that appears in my ETF portfolios.

While the ESG bond universe is expanding rapidly, investors won’t find a bond option targeting every nook and cranny of the bond market. Because I like to include short-term bonds as well as exposure to Treasury Inflation-Protected Securities in in-retirement portfolios, I relied on non-ESG funds for that portion of the portfolio. My logic was that 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.

Bucket 3: Years 11 and Beyond
15%: Parnassus Core Equity (PRBLX)
8%: Calvert US Large Cap Value Responsible Index (CFJAX)
7%: Brown Advisory Sustainable Growth (BIAWX)
7%: Parnassus Mid-Cap (PARMX)
5%: Boston Trust Walden Small Cap ((BOSOX) )
18%: Fidelity International Sustainability Index (FNIDX)

Bucket 3 of the portfolio is a globally diversified equity basket designed to supply the portfolio with long-term growth. With the domestic-equity portion of Bucket 3, my goal was to highlight some funds that have a strong ESG pedigree that also look solid from an investment perspective. I used funds from Parnassus to form the backbone of this portion of the portfolio. The firm has long been a leader in the ESG space; both Parnassus Core Equity and Parnassus Mid-Cap earn 5-globe sustainability ratings. Morningstar analysts have long looked favorably on Parnassus from an investment standpoint, too. The two funds receive Silver ratings from Morningstar’s analyst team, thanks to their reasonable expenses, stable manager situations, and sensible strategies. A focus on companies with predictable businesses helps to give both funds a defensive cast that makes them particularly appropriate as in-retirement equity holdings.

I also employed a small stake in Brown Advisory Sustainable Growth, a high-growth fund. Morningstar manager researchers award it a Silver rating for its management’s investment acumen as well as its proactive focus on companies with sustainable business models. In keeping with its focus on rapidly growing companies, especially in the technology and healthcare arenas, the fund’s performance has been strikingly good since its launch in 2013. But as with all growth strategies, I wouldn’t be surprised to see some reversion to the mean in the years ahead.

To help balance out the fund’s growth leanings, I employed a small stake in a value-oriented index fund managed by Calvert, another firm that has been a leader in the ESG investing space for many years. Its expenses are significantly higher than some other ESG index funds, but that’s because Calvert constructs its own indexes that pass its proprietary ESG research. The fund is available without a sales charge or transaction fee on supermarket platforms.

To supply some small-cap exposure to a portfolio dominated by large and midsize stocks, I employed Boston Trust Walden Small Cap. (Smaller investors shouldn’t be put off by its high listed minimum initial investment of $100,000, as it’s available at much lower levels through mutual fund supermarket platforms.) It's managed by an ESG-focused firm, Boston Trust/Walden, that has been around for years and is an established leader in shareholder engagement. The fund’s lead manager has been on the job for more than a decade, and performance has been solid if a bit streaky.

For international exposure, I've included Fidelity International Sustainability Index to provide low-cost, broad-based exposure to developed and emerging markets outside the U.S. The Bronze-rated Calvert International Responsible Index is another solid option with a heavier ESG emphasis, but it focuses on developed markets. 

Moderate ESG Mutual Fund Bucket Portfolio

Bucket 1: Years 1-2
10%: Cash

Bucket 2: Years 3-10
10%: Vanguard Short-Term Federal
10%: Vanguard Short-Term Inflation-Protected Securities
20%: PIMCO Total Return ESG

Bucket 3: Years 11 and beyond
12%: Parnassus Core Equity
7%: Calvert US Large Cap Value Responsible Index
5%: Brown Advisory Sustainable Growth
8%: Parnassus Mid-Cap
3%: Boston Trust Walden Small Cap
15%: Fidelity International Sustainability Index

Conservative ESG Mutual Fund Bucket Portfolio

Bucket 1: Years 1-2
12%: Cash

Bucket 2: Years 3-10
13%: Vanguard Short-Term Federal
15%: Vanguard Short-Term Inflation-Protected Securities 
20%: PIMCO Total Return ESG

Bucket 3: Years 11 and beyond
8%: Parnassus Core Equity
7%: Calvert US Large Cap Value Responsible Index
5%: Brown Advisory Sustainable Growth
5%: Parnassus Mid-Cap
3%: Boston Trust Walden Small Cap
12%: Fidelity International Sustainability Index

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 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). Meanwhile, 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 exchange-traded funds 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 funds launched to meet the need.

 

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

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