ESG-Focused Funds

An ESG-focused fund is a mutual, exchange-traded (ETF), or closed-end fund that invests according to a set of environmental, social, and governance principles. It does this while still aiming to provide a financial return on investment. While tensions often exist between the prioritization of ESG issues and asset managers’ fiduciary duty to maximize financial returns, the fact is that nearly three-quarters of investors now say that they have set ESG-related goals for their asset managers at a portfolio level.

A number of tools exist to help companies measure and report on their ESG performance. The best-known include CDP, the Global Reporting Initiative, and the Task Force on Climate-related Financial Disclosures. Moreover, there are now a number of private sector initiatives that provide companies with an independent assessment of their ESG performance. In addition to these tools, a company can also use its own internal processes and metrics to identify ESG opportunities and risks.

Investor demand for ESG-focused investments continues to grow. Nearly nine in ten investors surveyed said they expect asset managers to be more proactive about developing new ESG-oriented products. However, fewer than half of the asset managers surveyed plan to do so. The vast majority of them are instead focusing on converting existing products to allow them to be labeled as ESG-focused funds.

Why Are ESG-focused Funds Popular?

Investors are increasingly interested in companies’ impact on the world around them. They expect companies to take a more holistic approach to their business operations and consider their decisions’ wider implications. As a result, there has been a significant growth in the number of ESG-focused funds over the past few years. This trend has been encouraged by issues such as climate change, the COVID-19 pandemic, and growing concerns about income inequality.

A range of ESG-focused funds are available to investors, from funds that apply inclusionary or exclusionary screens to funds that focus on ESG-related engagement with issuers. Funds that market themselves as ESG-focused must disclose how they incorporate ESG factors into their selection processes and the extent to which their portfolios reflect ESG factors. 

ESG-Focused Funds Update

A new set of rules proposed by the Securities and Exchange Commission could require investors to consider carbon footprints when choosing ESG-focused funds. If adopted, the proposed rules would change the definition of materially deceptive or misleading in a fund prospectus or annual shareholder report by adding language that requires a fund to disclose the weighted average carbon intensity and carbon footprint information of its holdings.

As a result, the funds that are currently marketed as ESG-focused might need to change their names to comply with the proposed rules. The funds would also need to be required to tag any ESG-related disclosure information with the Inline eXtensible Business Reporting Language, which is designed to be machine-readable.