What you should know about ESG Funds

Mutual funds or ETFs are two forms of investments that can be oriented towards ESG investors.

Investing in environmental, social and governance (ESG) funds appeals to people for various reasons.

You might include ESG mutual funds or exchange-traded funds (ETFs) in your portfolioPortfolio All the different investments that an individual or organization holds. May include stocks, bonds and mutual funds.+ read full definition because you see the value of considering ESG factors in your investing decisions. Or you may include ESG funds because you want your investments to match your values. Or you may want to do both.

If you are considering an ESG fund, the fund’s investmentInvestment An item of value you buy to get income or to grow in value.+ read full definition objectives, strategies and risks can help you assess whether the fund aligns with your investment goals.

What are ESG funds?

Many ESG funds have sustainable, socially responsible, ethical or green labels. However, there’s no standard definition of these terms. That means the fund’s name alone may not give you enough information to guide you.

Consider the fund’s objectives and strategies

ESG-focused mutual funds and ETFs may have a range of objectives, in addition to financial performance. Some ESG considerations are used to steer the investment selection process. Others may put greater emphasis on aligning with an investor’s ESG-related values.

If you’re thinking of investing in an ESG-related fund, consider its objectives and strategies. Keep in mind, one single fund likely can’t address all the ESG issues that are important to you.

Some funds have one ESG objective. For example, a fund might focus on governance, such as promoting board diversity, without tackling environmental problems. While other funds may have governance objectives alongside environmental objectives, like reducing carbon emissions.

ESG funds use different strategies to reach their ESG objectives. These strategies give investors a window to the inner workings of a fund. Keep in mind a fund may use more than one strategy.

Why fund strategy matters

How a fund selects its investments impacts the overall portfolio, risk levels and its ability to achieve its ESG objectives.

Common ESG fund strategies

Below are some of the most common ESG fund strategies in use. A firm may use more than one ESG strategy and may use strategies that are not listed here.

Negative Screening The fund excludes certain securities or companies from its portfolio according to their ESG-related standards. For example, some funds exclude companies involved in the fossil fuel industry.
Best-in-Class or Positive Screening The fund invests in companies that perform better than their peers based on ESG-related performance metrics.
ESG Integration The fund explicitly accounts for ESG-related factors that are material to investment’s risk and return, alongside traditional financial factors, when making investment decisions.
Thematic Investing The fund seeks to investInvest To use money for the purpose of making more money by making an investment. Often involves risk.+ read full definition in sectors expected to benefitBenefit Money, goods, or services that you get from your workplace or from a government program such as the Canada Pension Plan.+ read full definition from long-termTerm The period of time that a contract covers. Also, the period of time that an investment pays a set rate of interest.+ read full definition macroeconomic ESG-related trends, such as those linked to the 17 UN sustainable development goals.
Impact Investing The fund aims to generate positive, measurable social or environmental impact alongside financial returns.
Stewardship or Active Ownership The fund uses its rights and position as a shareholderShareholder A person or organization that owns shares in a corporation. May also be called a investor.+ read full definition of companies that it invests in, including proxy voting, to influence the ESG-related activity of those companies. Some fund managers may engage with the management of these companies through meetings and written dialogue to influence their ESG-related practices.

The companies in a fund’s portfolio are determined by the ESG strategies the fund uses to achieve its objectives. For example, a fund aiming to promote environmental sustainability may choose a best-in-class strategy to identify and invest in leading environmental companies. Another fund, with the same objective, may invest in companies with less favourable environmental records but use a stewardship strategy to improve the companies’ environmental practices.

Before you buy or sell an investment, assess what ESG factors are already reflected in your portfolio.

You may not think of yourself as an ESG investor. But it’s a good idea to be aware of ESG strategies. A fund may be using an ESG strategy even though it isn’t marketed as ESG-related.

Assessing risk and suitability

The risk disclosure in a fund’s prospectusProspectus A legal document that sets out the full, true and plain facts you need to know about a security. Contains information about the company or mutual fund selling the security, its management, products or services, plans and business risks.+ read full definition outlines risks associated with investing in it. This may include risks arising from the fund’s ESG focus and its use of ESG strategies. This information can help you make an informed decision about risks.

The suitability statement can help you understand how an ESG fund aligns with your values and investment goals. The suitability statement, in the Fund FactsFund Facts A user-friendly guide that provides key information about a mutual fund including fees and performance. Mutual fund companies are required to give investors a copy of Fund Facts before they decide to purchase a fund.+ read full definition or the ETF Facts, outlines the type of investor who may consider the fund to be an appropriate investment.

5 steps to take as an ESG investor

  1. Start by identifying your investment goals and values — then assess which ESG funds match.
  2. Read the fund’s prospectus and Fund Facts or ETF Facts to learn more about the investment objectives and strategies for each investment you are considering.
  3. Search for investment objectives and strategies that align with your goals.
  4. Assess what ESG factors are already reflected in your portfolio.
  5. Talk to your financial advisor about next steps if your current investments don’t meet your ESG objectives.

Understanding the types of ESG funds is important, whether you are a do-it-yourself investor, use a robo-advisorRobo-advisor A business that offers professional money management services to investors over the internet. See also, Online Investment Advisor.+ read full definition or work with a financial advisor. Knowing a fund’s ESG focus and ESG strategies will help you make more informed decisions.

Last updated