ESG Mutual Fund Portfolios for Retirement Savers
Anchored in actively managed funds, these portfolios were developed with serious ESG investors in mind.
Sustainable mutual funds--which are also called ESG (environmental, social, governance) funds--have been soaring in popularity. In 2020, flows into ESG funds and ETFs surpassed $50 billion, more than double the amount they brought in in the year prior.
Interest in ESG investing comes from investors of all ages, but younger investors appear to have a particular affinity for investing in line with their personal principles. According to Morgan Stanley research, 87% of millennials (people born between the early 1980s and 1996) say they strong consider a company's ESG attributes when deciding whether to invest in it.
With the heightened level of interest in mind, I’ve created a series of ETF model portfolios geared toward people who are still accumulating assets for retirement, as well as “bucket” portfolios for people who are retired and actively drawing from their portfolios for living expenses.
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 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, that garner very high Morningstar Sustainability Ratings.
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. In addition to excluding companies that derive significant revenue from alcohol, tobacco, weapons, nuclear power, or gambling, analyst Stephen Welch notes they seek for 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 researchers to populate the portfolios with holdings with strong ESG and investment merits. Because the mutual fund portfolios encompass a heavier ESG emphasis than do the ETF portfolios, I would expect them to exhibit performance that differs more meaningfully from market benchmarks. 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.
Aggressive ESG Mutual Fund Retirement Saver Portfolio
15%: Parnassus Core Equity
10%: Calvert US Large Cap Value Responsible Index (CFJAX)
10%: Brown Advisory Sustainable Growth (BIAWX)
15%: Parnassus Mid-Cap (PARMX)
5%: Walden Small Cap (WASOX)
40%: Fidelity International Sustainability Index (FNIDX)
5%: PIMCO Total Return ESG (PTSAX)
With the domestic-equity portion of the portfolio, 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, and 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.
I also employed a small stake in Brown Advisory Sustainable Growth, a high-growth fund that Morningstar's manager researchers admire for its team'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 dominant in the ESG 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.) Its ESG-focused subadvisor, Boston Trust/Walden, 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 employed a relatively new index fund, Fidelity International Sustainability Index . That fund tracks a broadly diversified ESG index of non-U.S. stocks, the MSCI ACWI ex USA ESG Index. As such, it includes exposure to developed and emerging markets and stocks across the style and market-cap spectrum. It is suitable as for one-stop ESG exposure overseas, and as an index fund, it benefits from very low costs.
For fixed-income exposure, I swapped in PIMCO Total Return ESG in place of TIAA-CREF Social Choice Bond (TSBRX), which was recently downgraded to Neutral from Bronze. The PIMCO fund is an ESG version of the firm's flagship Total Return PTTRX. One important note is that while it's available through fund supermarkets like Schwab's, investors will need to pay a transaction fee to buy and sell. Thus, it won't be cost-effective for dollar-cost averagers; they would be better off in TIAA-CREF Social Choice Bond or in an ESG bond ETF like iShares ESG U.S. Aggregate Bond (EAGG).
Moderate ESG Mutual Fund Retirement Saver Portfolio
15%: Parnassus Core Equity
10%: Calvert US Large Cap Value Responsible Index
10%: Brown Advisory Sustainable Growth
15%: Parnassus Mid-Cap
5%: Boston Trust Walden Small Cap
25%: Fidelity International Sustainability Index
20% PIMCO Total Return ESG
Conservative ESG Mutual Fund Retirement Saver Portfolio
12%: Parnassus Core Equity
8%: Calvert US Large Cap Value Responsible Index
7%: Brown Advisory Sustainable Growth
7%: Parnassus Mid-Cap
3%: Boston Trust Walden Small Cap
15%: Fidelity International Sustainability Index
30% PIMCO Total Return ESG
7% Vanguard Short-Term Federal
11% Vanguard Short-Term Inflation-Protected Securities
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 and exposure to Treasury Inflation-Protected Securities in conservative portfolios, I relied on non-ESG funds for that portion of the portfolio. My logic was that U.S. government bond funds 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.
How to Use the Portfolios
As with all of the model portfolios, the key goal here is to depict sound asset-allocation and portfolio-maintenance principles, rather than to blow the doors off with strong performance. I'll make changes for rebalancing purposes or when fundamental considerations dictate--for example, there’s a manager change or worrying style shift.
Christine Benz does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.
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