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How to invest

ESG performance: What you need to know

Understand what an investment strategy focused on Environment, Social responsibility, and Governance (ESG) looks like and whether it's right for you.
7 minute read
  •  
September 13, 2022
How to invest
Understanding investment types
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ESGs
Active funds
Index funds

ESG funds are built differently and can act differently too. Although some investors speculate that ESG funds will either underperform or outperform the market, there’s evidence that both of those outcomes are possible.

What’s ESG investing?

ESG investing—which has recently grown in popularity—allows you to invest in products that consider environmental, social, and governance issues. Learn more about ESG investing here.

How do ESG funds perform?

While no one can definitively say whether ESG funds will underperform or outperform the market, we do know that their performance may differ from non-ESG securities, depending in part on the type of ESG fund.*

Exclusionary funds

Exclusionary ESG funds are index funds that avoid companies in certain industries and are built to track the broad market. They’ve been shown to perform similarly to their unconstrained benchmarks in the long run,* but have both underperformed and outperformed over shorter periods because of their sector composition. For example, since many ESG funds aren’t heavily weighted in energy companies, if the energy industry has an outstanding year, the ESG market will underperform compared to the broader market.

Active funds

Active ESG funds perform differently than their benchmarks by design. Since portfolio managers handpick investments with the goal of beating the market over the long term, an active ESG fund’s performance is dependent on its fund manager’s skills, not just ESG-related factors. While outperformance is the goal, even the most successful active funds can experience frequent periods of underperformance.**

Active ESG funds may not be suitable for every investor. They usually come with higher costs and risks and are more often considered an addition to a balanced portfolio rather than a core holding.

Choose the right ESG funds for you

Use this framework to understand which funds are the right fit for your portfolio.

Vanguard’s approach to ESG investing

Most Vanguard products consider ESG factors to some extent—even the ones that aren’t built with specific environmental or social goals. We use engagement and integration to factor ESG into what we offer.

Engage

For Vanguard’s equity index funds, the Vanguard Investment Stewardship team engages directly with company executives and board members to better understand how companies address material risks, including material ESG risks. For Vanguard’s externally managed active funds, investment stewardship activities are carried out by advisors selected and hired by Vanguard.

Integrate

Our active fund investment managers work to integrate ESG and other financially material considerations into their investment process. This careful analysis gives managers a more complete picture of a security’s risks and opportunities.

Vanguard also offers investment products that are designed and built expressly with ESG outcomes in mind. We offer investors a choice of ESG products that reflect their investment and sustainability goals through our avoid and allocate approaches.

Avoid

Our passively managed exclusionary ESG products avoid companies in certain industries that don’t meet ESG standards. We currently offer 4 ESG index funds that use transparent exclusion measures to remove companies that don’t meet ESG screening criteria.

Allocate

For investors looking for outperformance from ESG investments, our low-cost actively managed products carefully allocate capital to companies with leading or improving ESG practices. We work with top-quality active managers who are respected leaders in ESG investing.

Discover our lineup of ESG funds and choose the right one for you

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*Plagge, Jan-Carl, and Douglas Grim. Have Investors Paid a Performance Price? Examining the Behavior of ESG Equity Funds. The Journal of Portfolio Management. 2020.

**Tidmore, Chris, and Andrew Hon. Patience With Active Performance Cyclicality: It's Harder Than You Think. The Journal of Investing. 2021.

All investing is subject to risk, including the possible loss of the money you invest.

For more information about Vanguard funds or Vanguard ETFs, obtain a mutual fund or an ETF prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information are contained in the prospectus; read and consider it carefully before investing.

ESG funds are subject to ESG investment risk, which is the chance that the stocks or bonds screened by the index provider for ESG criteria generally will underperform the market as a whole or, in the aggregate, will trail returns of other funds screened for ESG criteria. The index provider’s assessment of a company, based on the company’s level of involvement in a particular industry or the index provider’s own ESG criteria, may differ from that of other funds or of the advisor’s or an investor’s assessment of such company. As a result, the companies deemed eligible by the index provider may not reflect the beliefs and values of any particular investor and may not exhibit positive or favorable ESG characteristics. The evaluation of companies for ESG screening or integration is dependent on the timely and accurate reporting of ESG data by the companies. Successful application of the screens will depend on the index provider’s proper identification and analysis of ESG data. The advisor may not be successful in assessing and identifying companies that have or will have a positive impact or support a given position. In some circumstances, companies could ultimately have a negative impact, or no impact.