27, 2021 09:00 AM / by US SEC / Header Image Credit: Mint
Funds such as mutual funds and ETFs that focus on
environmental, social, and governance principles (ESG Funds) have gained popularity
with investors over time. Investors may hear about these funds from financial
professionals, from investment-focused online sites, or even from popular
media. The SEC's Office of Investor Education and Advocacy is issuing this
bulletin to educate investors about ESG Funds, including important questions to
ask if considering whether investing in them is right for you.
What is an ESG Fund?
Funds, like ETFs and
mutual funds, may consider a wide range of factors that are consistent with
their objectives and strategies when selecting investments. This can include
ESG, which stands for environmental, social, and governance.
ESG investing has
grown in popularity in recent years, and may be referred to in many different
ways, such as sustainable investing, socially responsible investing, and impact
investing. ESG practices can include, but are not limited to, strategies that
select companies based on their stated commitment to one or more ESG factors -for example, companies with policies aimed at minimizing their negative impact
on the environment or companies that focus on governance principles and
transparency. ESG practices may also entail screening out companies in
certain sectors or that, in the view of the fund manager, have shown poor performance
with regard to management of ESG risks and opportunities. Furthermore, some
fund managers may focus on companies that they view as having room for
improvement on ESG matters, with a view to helping those companies improve
through actively engaging with the companies.
Funds that elect to
focus on companies' ESG practices may have broad discretion in how they apply
ESG factors to their investment or governance processes. For example, some
funds integrate ESG criteria alongside other factors, such as macroeconomic
trends or company-specific factors like a price-to-earnings ratio, to seek to
enhance performance and manage investment risks. Other funds focus on ESG
practices because they believe investments with desired ESG profiles or
attributes may achieve higher investment returns and/or encourage ESG-related
outcomes. For example, some ESG funds select companies that have shown their
commitment to a particular ESG factor, such as companies with policies aimed at
minimizing their negative impact on the environment. Some funds may
implement shareholder voting rights in particular ways to achieve ESG goals,
while others may only focus on selecting investments based on ESG criteria.
Fund managers focusing
on ESG generally examine criteria within the environmental, social, and/or
governance categories to analyze and select securities.
- The environmental
component might focus on a company's impact on the environment-for
example, its energy use or pollution output. It also might focus on the
risks and opportunities associated with the impacts of climate change on
the company, its business and its industry.
- The social component
might focus on the company's relationship with people and society-for
example, issues that impact diversity and inclusion, human rights, specific
faith-based issues, the health and safety of employees, customers, and
consumers locally and/or globally, or whether the company invests in its
community, as well as how such issues are addressed by other companies in
a supply chain.
- The governance
component might focus on issues such as how the company is run-for
example, transparency and reporting, ethics, compliance, shareholder
rights, and the composition and role of the board of directors.
An ESG fund portfolio
might include securities selected in each of the three categories-or in just
one or two of the categories. A fund's portfolio might also include securities
that don't fit any of the ESG categories, particularly if it is a fund that
considers traditional fundamental analysis or other investment
methodologies consistent with the fund's investment objectives.
ESG investing is not
limited to ETFs and mutual funds. Other types of investment products, like
exchange-traded products that are not registered under the Investment Company
Act of 1940, might also consider ESG factors in selecting an investment
Be sure you understand
what you are investing in.
If you are considering
investing in an ESG Fund, you should know that all ESG Funds are not the same.
It is always important to understand what you are investing in, and to be sure
a fund, or any other investment, will help you achieve your investment goals.
In addition, you will likely want to consider whether a fund's stated approach
to ESG matches your investment goals, objectives, risk tolerance, and
Here are some things
- Some factors are not defined in
federal securities laws, may be subjective, and may be defined in
different ways by different funds or sponsors. There is no SEC
"rating" or "score" of E, S, and G that can be applied across a broad
range of companies, and while many different private ratings based on
different ESG factors exist, they often differ significantly from
- Some funds may focus on ESG
investing, while others consider ESG factors alongside other more
- Different funds may weight
environmental, social, and governance factors differently. For example,
some ESG Funds may invest in companies that have strong governance
policies, but may not have the environmental or social impact you may want
to encourage through your investment in the fund.
- Different funds may focus on
different specific criteria within a factor. For example, one fund may
focus on shareholder rights for "governance," while another focuses on
board of directors' diversity.
- Some ESG fund managers may
consider data from third party providers. This data could include
"scoring" and "rating" data compiled to help managers compare companies.
Some of the data used to compile third party ESG scores and ratings may be
subjective. Other data may be objective in principle, but are not verified
or reliable. Third party scores also may consider or weight ESG
criteria differently, meaning that companies can receive widely different
scores from different third party providers.
- You can find more information
about how a fund incorporates ESG and how it weighs ESG factors in the
fund's disclosure documents. The fund's prospectus contains important
information about its investment objective and strategies, and its
shareholder report contains both a list of its top holdings and a
graphical representation of its holdings by category. These documents, and
in some cases supplemental information, are available on funds' websites.
- Some funds that don't have "ESG"
in the name may still incorporate elements of ESG investing into their
portfolios. Consider comparing an ESG Fund's portfolio to other fund
portfolios to be sure you are investing in a fund that is consistent with
your investment goals.
- Funds' websites may also have
policy statements that more fully explain their ESG practices, and other
information such as customized statistics about the relevant ESG
attributes or approaches used by the fund.
Understand What an ESG
Investment Strategy Could Mean for You
As with any
investment, you could lose money investing in an ESG Fund.
- A portfolio manager's ESG
practices may significantly influence performance. Because securities may
be included or excluded based on ESG factors rather than traditional
fundamental analysis or other investment methodologies, the fund's
performance may differ (either higher or lower) from the overall market or
comparable funds that do not employ similar ESG practices.
What this may mean for you: ESG funds may perform differently than other funds without the ESG
- Certain industries may be excluded
from some ESG Fund portfolios. However, some ESG Funds may still invest in
"best in class" companies within commonly excluded industries. For
example, an ESG Fund could invest in a certain company within an industry
where companies commonly have a large carbon footprint because that
company demonstrated a commitment to improving its policies and practices
on environmental issues. Moreover, companies which may score poorly on one
ESG factor (such as carbon footprint) could be selected because they score
well on another ESG factor (strong governance) or because the fund manager
has plans to engage with the companies to improve their performance on ESG
What this may mean for you: One of the most important ways to reduce the overall risk of investing is
to diversify your investments. You should read the fund's disclosure documents
closely to be sure you understand what the fund is-and is not-invested in, and
how its ESG orientation may affect its risk.
- Some funds that consider ESG may
have different expense ratios than other funds that do not consider ESG
What this may mean for you: You should always evaluate a fund's expenses. Paying more in expenses will
reduce the value of your investment over time.
Be sure to consider
all of your goals when weighing any potential benefits and risks to making a
Before you invest in an
- Carefully read all of the fund's available information,
including its prospectus and most recent shareholder report. You can get this
information by looking at the fund's filings on the SEC's EDGAR database, from your investment professional, or
directly from the fund.
- Understand the fees and
expenses you will pay for the fund, and compare them to other investment
- Be sure that the fund's investment strategy is
consistent with your goals.
- Ask Questions:
- Is ESG a core component of the investment selection
process, or is it one of many factors that are considered to select
- To what extent does the fund focus on ESG factors versus
more traditional factors?
- How does the fund weight each of the three ESG factors
within its ESG portfolio holdings?
- What specific criteria within a factor does the fund use
when determining its portfolio holdings?
- How do the fund's fees and expenses compare to other
- What types of investments do you expect or desire the
fund to be invested in, and what types of investments do you expect or desire
the fund NOT to be invested in? Compare those expectations with published
fund holdings to better understand whether the fund's investment strategy is
consistent with your preferences.
- How does the fund explain and discuss its ESG practices,
and how do those practices affect the performance and risk of the fund?
- Is the fund employing an ESG practice that is of
importance to you, such as voting proxies in a certain manner or engaging with
issuers to influence their ESG practices?
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