A Rose by Any Other Name? Identifying Responsible Investing Funds

In the U.S., mutual fund and ETF assets earmarked for funds dedicated to responsible investing (RI, aka ESG, sustainable, socially responsible, or impact investing) practices only accounted for 1.3% (+$371.3 billion) of the assets under management (+$29.225 trillion). Nonetheless, the number of RI offerings continues to grow as investors search for strong risk-adjusted returns while staying true to their ethical, moral, sustainable, and religious convictions.

At year’s end, there were 802 ETFs or unique conventional funds (excluding share classes) flagged in Lipper’s database as being committed to RI practices. This means these funds have stated goals of not just considering ESG or ethical metrics in the decision-making process but committing the majority of their assets and resources to their stated responsible goals—with a clear commitment to measuring and implementing those stated investment objectives—without making concessions on returns.

This could include a steadfast commitment to using negative screens, such as excluding firms in the adult entertainment industry, alcohol, tobacco, weapons, or petroleum sectors. It could also include the search for best-in-practice firms that focus on finding those companies, sometimes in out-of-favor industries, that are committed to shrinking their carbon footprint, finding alternative energy sources, improving workforce diversity, or finding those firms that have focused impact strategies, such as providing affordable housing or other unique visions that support clients’ unique missions.

With these diverse RI options blossoming over the last several years, investors need to make sure that they do the extra due diligence when researching RI funds in order to find the right funds that fit their particular convictions—it isn’t a one-size-fits-all concept.

U.S. investors have access to a broad range of fund and ETF offerings that will help them achieve their responsible investing pursuits. As of December 31, 2022, there were 109 Lipper classifications that contained RI-focused funds and ETFs, helping investors, financial planners, and investment advisors create a well-diversified portfolio of RI choices, using both actively and passively managed offerings.

Although because of the nature of the RI processes, which are tailored to a client’s particular convictions, actively managed RI funds (598 unique funds, excluding share classes) with their increased flexibility and ability to engage in active ownership and shareholder activism outnumber their passively managed RI counterparts (204 unique funds).

That said, and in line with what we reported in other segments, for the one-year period ended December 31, 2022, passively managed RI funds and ETFs attracted net new money, taking in some $3.5 billion, while their actively managed RI counterparts handed back some $8.2 billion. In comparison, on the non-RI side of the ledger, actively managed funds (excluding RI funds) suffered $1.034 trillion in net redemptions for 2022, while their passively managed counterparts attracted a net $558 billion. So, investors on both sides of the equation appeared to favor passively over actively managed offerings during the year.

Despite equity and taxable fixed income funds (including ETFs) posting handsome fourth quarter returns of 8.77% and 2.44%, respectively, RI investors were net redeemers in Q4, withdrawing $7.6 billion from actively managed RI funds and ETFs, and $2.4 billion for passively managed RI funds and ETFs—with RI funds suffering combined outflows for Q4 of $10.0 billion.

The strong performance witnessed during the quarter was the catalyst to the growth in total net assets (TNA) in the RI subset for Q4, with assets under management rising 4.56% from $355.1 billion on September 30, 2022, to $371.3 billion on December 31, 2022.

For those readers who have followed this segment over the years, one might have noticed that the assets under management in RI funds at the end of this year are significantly lower than the prior year. This is a result of our organization taking a more conservative approach in identifying and verifying claims by funds of being sustainable, ESG, impact, or socially focused.

For a fund to be flagged as Ethical or Responsible Investing at Lipper, we believe the fund needs greater commitment and clearly stated language on how the fund will meet those stated objectives. One-liners, such as the following, in fund documents are not sufficient to gain an ethical or responsible investment designation: the investment advisor may consider environmental, social, and governance (ESG) factors that, depending on the facts and circumstances, are material to the value of an issuer.

While many fund companies, commendably, are including sustainable considerations as one of many parameters in their selection process, to be used in concert with other clearly stated selection criteria (bottom-up, top-down, deep value, growth, quantitative, to mention only a few), responsible investing practices are not necessarily the primary focus. In some of these cases, the portfolio managers, in their pursuit to meet their fiduciary responsibilities, are allowed to deviate away from the responsible investment mandate in the pursuit of better returns.

So, to help fund investors confidently identify funds with a primary commitment to environmental, social, or governance investment focus, we are purposely limiting these flags or designations to funds with clearly stated sustainable investment mandates. As a result, we removed the RI designation from several funds over the year.

No disrespect or shade is intended for those funds. Again, many of these funds have begun to use ESG factors as one of many security selection criteria, but the main investment objective or focus is not responsible investing—at this time.

Fortunately, regulators around the world have begun to establish better guidelines to help investors clearly identify funds with sustainable investment mandates and guard against greenwashing practices. In a recent segment, my cohort Detlef Glow wrote “ . . . it is no surprise that regulators around the world have begun to increase the pressure on the fund industry with regard to the use of sustainability-related terms within the fund name, as this could be misleading for investors.”

For the U.S., he stated, “The Securities and Exchange Commission (SEC) proposed an extension to the existing “fund names rule” to investments suggested in a strategy’s name, requiring that 80% of a fund’s assets adhere to the approaches specified in the fund name. The proposed change aims to minimize the room for interpretation by giving clear specifications and will not only be applicable for fund names which include one or more environmental, social, and governance factors, but also for strategies using growth, value, geography, or industry/sector approaches.”

And this new initiative will help investors identify RI funds more effectively; however, there are several fund families and funds that are truly socially focused in their practices but don’t use any of the buzzwords in their names. For example, in 1928 an ecclesiastical group created the first publicly available investment fund (Pioneer Fund, A Shares [PIODX]) to screen out tobacco, alcohol, and gambling investments—that fund remains active today and might not be identified as RI fund because of its name. So, investors can’t just depend on an update in the Names Rule.

Other instances include multiple fund and ETF offerings from the likes of Parnassus, Amana/Saturna, Calvert, Impax, and Steward, only to name a few—all committed to some sort of social, environmental, or sustainable investment mandate. Thus, our renewed focus and dedication to identify clear mandates and detailed examples of a fund’s obligation and means to measure responsible investing practices in the prospectus, statement of additional information, and proxy statements.