In September, Vanguard, the second-largest U.S. issuer of exchange traded funds, launched its first ETFs aimed at environmental, social and governance (ESG) investing principles.
The Vanguard ESG U.S. Stock ETF (NYSEArca: ESGV) and the Vanguard ESG International Stock ETF (NYSEArca: VSGX) are low-cost entrants to the growing ESG ETF arena and cover more than 80% of the U.S. equity market capitalization and nearly 70% of the international equity market capitalization, with a focus on those companies that adhere to ESG principles.
However, some market observers are critical of these new funds, saying the new ESG funds from Vanguard miss some important ESG considerations.
“The problem is that these funds aren’t really ESG funds, at least not in the sense that I would define the term,” said Morningstar in a recent note. “Granted, the ESG space has some challenges with terminology reflecting varied approaches, but, for the most part, funds calling themselves ‘ESG’ today explicitly integrate environmental, social, and corporate governance criteria to select companies with positive ESG characteristics.”
The new ESG ETF’s underlying indices exclude companies producing adult entertainment, alcohol and tobacco products, conventional and controversial weapons (including civilian firearms), fossil fuels, gambling activities, and nuclear power. The indices also exclude companies that do not meet certain diversity criteria, as well as the labor, human rights, anti-corruption, and environmental standards defined by the Ten Principles of the United Nations Global Compact.
Vanguard ETFs “throwbacks”
Morningstar called the new Vanguard ETFs “throwbacks” to a time when ESG screening centered around a limited, often more negative screening process to weed out the likes of tobacco companies and firearms manufacturers.
“Rather than tilting toward companies with better ESG profiles, the Vanguard funds simply use negative screens to exclude a relatively few companies from a broad market index,” said Morningstar.
Investing based on environmental, social and governance (ESG) principles is a theme garnering increased attention, but in the U.S., the 50 or so ESG ETFs have just over $6 billion in combined assets under management. Last month, BlackRock, the largest ETF issuer, said it sees the ESG fund universe jumping to $400 billion over the next decade.
ESGV and VSGX, Vanguard’s new ESG products, charge just 0.12% and 0.15% per year, respectively, and those low fees could lure investors, but investors should look at more than just fees.
“Many will make their first ESG investment in these funds, and many will think, incorrectly, that exclusionary screening is what ESG is all about. A focus on screening rather than positive ESG integration could also lead to underperformance,” according to Morningstar.
For more information on new fund products, visit our new ETFs category.