Vanguard FTSE Social Index I VFTNX Sustainability

Vanguard FTSE Social Index Fund has a number of positive attributes that may appeal to sustainability-focused investors.

This strategy has an above-average Morningstar Sustainability Rating of 4 globes, indicating that the ESG risk of holdings in its portfolio is relatively low compared with those of its peers in the US Equity Large Cap Blend category. ESG risk provides investors with a signal that reflects to what degree their investments are exposed to risks related to material ESG issues, such as climate change and inequalities, that are not sufficiently managed. ESG risk differs from impact, which is about seeking positive environmental and social outcomes.

Vanguard FTSE Social Index Fund holds itself out to be a sustainable or ESG-focused investment. In other words, ESG concerns are central to the investment process of this strategy. A fund with an ESG-focused mandate would have a higher probability to drive positive ESG outcomes. One key area of strength for Vanguard FTSE Social Index Fund is its low Morningstar Portfolio Carbon Risk Score of 4.54 and very low fossil fuel exposure over the past 12 months, which earns it the Morningstar Low Carbon Designation. Thus, the companies held in the portfolio are in general alignment with the transition to a low-carbon economy.

Its 15.84% involvement in carbon solutions is higher than the 10.65% average involvement of its peers in the Large Blend category. Carbon solutions include products and services related to renewable energy, energy efficiency, green buildings, green transportation, and so on. By prospectus, the fund aims to avoid, or limit its exposure to, companies associated with controversial weapons, tobacco, thermal coal, and small arms. The fund fulfills this goal as its investment exposure to each of these activities is negligible.

The fund exhibits moderate exposure (8.02%) to companies with high or severe controversies. From bribery and corruption to workplace discrimination and environmental incidents, controversies are incidents that may negatively affect stakeholders, the environment, or the company’s operations.

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.