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Vanguard European Stock Index Admiral VEUSX Sustainability

| Analyst rating as of

Sustainability Analysis

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Sustainable Summary

Vanguard European Stock Index Fund is likely to concern sustainability-focused investors given certain substandard ESG attributes.

This fund has the second-lowest Morningstar Sustainability Rating of 2 globes, indicating it holds securities with relatively high ESG risk compared to that of its peers in the Europe Equity Large Cap category. Investors concerned about ESG risk may be better off with funds in the category that receive 4 or 5 globes as they tend to hold securities less exposed to ESG risk. ESG risk measures the degree to which material environmental, social, and governance issues, such as climate change and inequalities, could affect valuations. ESG risk differs from impact, which is about driving positive environmental and social outcomes for society’s benefit.

One potential issue for a sustainability-focused investor is that Vanguard European Stock Index Fund doesn’t have an ESG-focused mandate. Funds with an ESG-focused mandate would have a higher probability to drive positive ESG outcomes. The fund's current involvement in fossil fuels reaches 11.16%, surpassing 9.22% for its average category peer. Companies are considered involved in fossil fuels if they derive some revenue from thermal coal, oil, and gas.

The fund has an asset-weighted Carbon Risk Score of 8.49, indicating that its current equity and/or bond holdings have low exposure to carbon-related risks. These are risks associated with the transition to a low-carbon economy such as increased regulation, changing consumer preferences, technological advancements, and stranded assets.

The fund has a modest level of exposure (6.32%) to companies with high or severe controversies. Companies with high or severe controversies are involved in incidents such as corruption, employee abuses, environmental incidents, and corporate scandals that pose serious business risks to the company.

ESG Commitment Level Asset Manager

 | Low

The Vanguard Group’s ESG efforts continue to improve, but so have many competitors’, and the firm itself still doesn’t stand apart. It earns a Morningstar ESG Commitment Level of Low.

Passive ESG-focused strategies at Vanguard number around 20 across the United States, Europe, and Australia, but they amount to only a fraction of assets under management, and most use negative screens to exclude companies in controversial industries and those that run afoul of ethical and environmental standards. In practice, the screens of these strategies do not differentiate the funds from their broader universes as much as peers that explicitly integrate ESG criteria to select companies with positive ESG characteristics.

Vanguard’s in-house fixed-income group has a six- to seven-person ESG committee that leverages third-party ratings to assign an ESG risk rating of Low, Medium, and High to each issuer. But the firm’s virtual indexing approach even within most of its active bond strategies keeps any ESG tilts fairly modest.

Using external subadvisors for most of Vanguard’s actively managed equity strategies results in a wide range of ESG approaches. Morningstar ESG Commitment Levels at the strategy level assess those approaches and firms for Vanguard’s single-subadvisor funds, but three of Vanguard’s largest subadvisory relationships are worth noting here. While Primecap’s long-term focus on value-creating businesses aligns with many sustainable-investing frameworks, Primecap is reticent to incorporate standardized ESG metrics into its company evaluation process. Wellington, on the other hand, has sought to do just that to some degree for all its strategies and since mid-2019 has run the fully integrated Vanguard Global ESG Select Stock VESGX. Baillie Gifford, too, has a maturing sustainable-investing approach, and in 2022 Vanguard plans to adopt one of Baillie Gifford’s previously existing strategies and rename it the Vanguard Baillie Gifford Global Positive Impact Stock Fund.

The Baillie Gifford strategy is an early sign of the influence of Vanguard’s recently formed ESG global product team, headed by firm veteran Matthew Piro. Buttressed by the expertise of experienced hires, like Fong Yee Chan, this team has the potential not just to add other appealing ESG options to Vanguard’s lineup but also to refine the ESG evaluation of current subadvisors. Even so, Vanguard is likely to remain tolerant of varying ESG commitments within its equity lineup. Moreover, disclosure of ESG metrics and risks for Vanguard products across the board are still lacking.

Active ownership is a bright spot at Vanguard through its investment stewardship team, whose membership grew from 35 in 2020 to around 60 by the end of 2021. In that year’s first half alone, this group engaged more than 700 companies in 29 countries on ESG issues and voted on nearly 140,000 proposals while providing commentary on key votes. Yet, the team was undersized previously, many members are new to their roles, and support of key ESG resolutions has risen but continues to be lower than other big asset managers.