8 Top Funds for Sustainable Investing

Editor’s note: This article first appeared in the Q3 2021 issue of Morningstar magazine. Click here to subscribe.

We recently launched environmental, social, and governance-specific ratings on more than 800 funds. In this article, we explain the work and highlight our analysts’ assessments of some of the elite funds in this area.

The ability to outperform traditional benchmarks while pursuing sustainability initiatives has often seemed an elusive goal for investors. Using the Morningstar Analyst Rating together with the newly launched Morningstar ESG Commitment Level, investors can now identify funds that deliver the best of both worlds.

The Morningstar ESG Commitment Level helps investors understand where a strong ESG approach fits within a fund’s broader investment objectives. It is a qualitative measure of the extent to which asset managers and funds incorporate ESG considerations into their investment processes. The scale runs from best to worst: Leader, Advanced, Basic, and Low.

Firms and strategies that earn the Leader designation integrate ESG factors fully into their security analysis and portfolio construction, and they deliver desirable ESG outcomes at the portfolio level, such as a high sustainability profile or advancement of the U.N. Sustainable Development Goals. These firms boast impressive ESG resources, and they typically have best-in-class practices for reporting and disclosure. For Advanced firms and strategies, ESG considerations are a key part of the investment process, even if they fall short of Leader funds in one or more areas. We currently have ESG ratings on more than 800 strategies and 70 asset managers.

The Top Funds The Morningstar 500 is a select list of funds that are among the industry's most notable. It is featured exclusively in the Morningstar FundInvestor newsletter. Eight Morningstar 500 funds earn top marks for both their Morningstar Analyst Ratings, which evaluate a strategy's future potential for outperformance, and ESG Commitment Levels. Exhibit 1 shows the Morningstar 500 funds that earn Analyst Ratings of Gold, Silver, or Bronze and an ESG Commitment Level of either Leader or Advanced.

Parnassus is the sole asset manager on this list that earns an ESG Commitment Level of Leader. It boasts decades of experience in responsible investing, as evidenced in the high quality of ESG integration in its intentionally sustainable funds.

Leader Funds Parnassus Core Equity PRBLX, Parnassus Mid-Cap PARMX, Parnassus Mid Cap Growth PARNX

Parnassus offers three equity funds that are Morningstar Medalists and earn ESG Commitment Levels of Leader. These funds are driven by a rigorous, firmwide approach to ESG investing that is a head above the competition. The firm’s focus on sustainable investing dates to its 1984 inception, resulting in a steady investment team with substantial experience in the field. This experienced team produces topnotch ESG research, which is a key driver of security selection and portfolio construction, risk management, and proxy-voting strategies.

Parnassus’ funds apply the same firmwide philosophy in each strategy. The process excludes companies involved in controversial businesses and then employs ESG, quality, and valuation screens to filter out about 85% of the benchmark. From there, managers look for companies with sustainable competitive advantages, increasingly relevant products or services, exemplary management, and ethical practices. For example, VF VFC is an outdoor apparel company focused on improving its sustainability by setting science-based targets for carbon intensity and leading the way in circular business models.

The resulting portfolios are concentrated, with a focus on downside protection and stable competitive footing. This leads to a quality bias, but the managers also consider valuation, ensuring that the portfolio holdings are not overly expensive. Management skillfully blends sound investing principles and ESG expertise in this compelling suite of funds.

TIAA-CREF Core Impact Bond TSBIX TIAA-CREF Core Impact Bond is a worthwhile ESG mandate wrapped in a solid relative-value-driven process. A robust team incorporates traditional ESG screening alongside proprietary rankings and impact investments, making this one of the purest ESG bond strategies out there.

Lead manager Steve Liberatore is a firm veteran and heads up the firm’s ESG and impact investing efforts in fixed income. He is backed by two comanagers and over 100 investment professionals.

The firm’s 28-person ESG team ranks potential investments according to a proprietary ESG framework. Most of the fund’s assets are invested in the top performers according to this ESG research. The remainder of the portfolio is dedicated to impact investments, which are bonds issued to finance a project that results in a “direct and measurable” impact toward some ESG goal. The fund’s ESG mandate, robust resources, and incorporation of impact investments make for a strong overall fund.

Advanced Funds Brown Advisory Sustainable Growth BIAWX

An experienced group with solid ESG resources drives Brown Advisory Sustainable Growth’s patient and unique approach to sustainable investing.

In a space where most view ESG as an additional layer of risk oversight, this team considers ESG criteria to be the primary driver of the fundamental outlooks for portfolio holdings. Broad exclusions of controversial industries are common in ESG investing, but this fund takes a more nuanced approach. It seeks companies with durable ESG-driven competitive advantages that ultimately lead to cost reduction, increased revenues, or enhanced franchise values. The group conducts a thorough ESG risk assessment for each holding, as well as a sustainable business advantage report.

While the fund doesn’t employ negative screens, it has steered clear of traditionally controversial segments of the market, such as fossil fuels and firearms, because firms in those areas haven’t met their proprietary ESG criteria. This distinguished fund is the result of skillfully blending ESG research with a preference for businesses with sustainable competitive advantages.

Vanguard Global ESG Select Stock VESGX This fund hasn't been around very long, but it draws on deep ESG resources at subadvisor Wellington and has already established itself as a respectable offering with a lot of promise.

Vanguard launched the fund in June 2019 as the first actively managed ESG fund in the firm’s

lineup. The manager duo is supported by Wellington’s 20-person ESG and sustainable investment team, which compares well with those at other big diversified asset managers.

The fund’s process integrates ESG considerations into stock-picking and portfolio construction. After narrowing the investment universe to 150 promising names, the portfolio managers subject each of these to a research deep dive from both a fundamental and an ESG perspective. They look for firms where executives have shown skill at capital allocation, have priorities aligned with a variety of stakeholders, and have shown a willingness to engage on important issues. This fund’s short track record means that some caution is still warranted, but so far, the managers have done a fine job of establishing its ESG bona fides.

BlackRock Advantage ESG U.S. Equity BIRAX This fund boasts unrivaled resources and innovative research, but its implementation leaves some room for improvement.

The fund’s proprietary systematic model has two objectives: minimize tracking error versus the Russell 3000 Index and deliver a portfolio with better ESG and carbon intensity metrics than the index. To stay within its narrow tracking band relative to the index, the fund may invest in poorly rated companies that other ESG funds would exclude, such as Valero Energy VLO and Facebook FB.

While the fund’s tight tracking error might dissuade the strictest ESG investor, the research driving the fund’s quantitative model is indisputably topnotch. Many peers see sustainability and economic return as mutually exclusive targets, but this team’s research emphasizes the synergy between the two. For example, the team examines a company’s compensation strategy for two reasons: to understand employee satisfaction and to indicate a team’s resilience in a crisis such as the COVID-19 pandemic. This fund’s rigorous research agenda and systematic implementation raise it a step above other core equity offerings in the ESG space.

TIAA-CREF Social Choice Equity TICRX TIAA-CREF Social Choice Equity has a long history of incorporating sustainability into its investment process, and the team behind it draws on a deep well of ESG resources, though it's not yet a leader in disclosure and reporting.

This is one of the oldest ESG mutual funds around, having been launched in 1999. It still uses a version of the same quasi-index strategy it has employed for the past 20 years. It doesn’t track an index, but management aims to replicate the risk profile of the Russell 3000 benchmark, using only stocks that meet a strict proprietary set of ESG standards.

Nuveen’s Responsible Investing team sets those standards and tailors them to each sector and industry. The team at MSCI does the nitty-gritty work of identifying which stocks meet the criteria, eliminating roughly half of the universe. This approach isn’t flashy, but it has worked well for a long time.

The Nuveen Responsible Investing team is one of this fund’s strengths. At close to 30 members, it’s one of the largest such teams among peers. The team includes sector specialists and specialists in ESG integration, engagement, and impact investing. With a solid track record and a parent firm that’s committed to continually improving its ESG capabilities, this fund has plenty of good things to offer.

Alyssa Stankiewicz is a sustainability analyst with Morningstar Research Services LLC.