ESG Sustainability Investing

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>>> This ESG Fund From Vanguard Is Off to a Good Start


The managers of the firm's first actively managed environmental, social, governance fund take a sensible, concentrated approach.


by David Kathman

Oct 21, 2020


https://www.morningstar.com/articles/1005324/this-esg-fund-from-vanguard-is-off-to-a-good-start


Mentioned: Atlas Copco AB (ATLKF), Vestas Wind Systems A/S (VWSYF), Merck & Co Inc (MRK), Microsoft Corp (MSFT), Deere & Co (DE), Danaher Corp (DHR), Taiwan Semiconductor Manufacturing Co Ltd (TSM), Vanguard Global ESG Select Stk Investor (VEIGX)

The following is our latest Fund Analyst Report for Vanguard Global ESG Select Stock (VEIGX). Morningstar Premium Members have access to full analyst reports such as this for more than 1,000 of the largest and best mutual funds. Not a Premium Member? Gain full access to our analyst reports and advanced tools immediately when you try Morningstar Premium free for 14 days.

Vanguard Global ESG Select Stock (VEIGX) has shown promise so far, but it still has plenty to prove given its short track record. It earns a Morningstar Analyst Rating of Bronze for both its Investor and Admiral shares.

Vanguard launched this fund in June 2019 as the first actively managed environmental, social, and governance fund in its lineup. It's subadvised by Wellington, which has had a fruitful decades-long relationship with Vanguard, and managed by Mark Mandel and Yolanda Courtines, former career research analysts at Wellington. Neither Mandel nor Courtines has managed a mutual fund before this one, but it helps that they're supported by Wellington’s deep and experienced team of global industry analysts and its fine ESG and sustainable investment team.

The process is a sensible one, without many bells and whistles. With the help of the analyst teams, Mandel and Courtines start with an investment universe of 750 large, highly liquid global stocks and narrow it down to a concentrated portfolio of 35-45 names. Returns on capital play a major role in their investment philosophy, which favors companies combining high and sustainable returns on equity with strong stewardship. The latter term encompasses traditional ESG concerns as well as broader issues of good corporate management. Among other things, the managers look for companies where executives have shown skill at effective capital allocation and have priorities aligned with a variety of stakeholders. They aim to keep the portfolio diversified, though there are few formal constraints. Valuation plays only a secondary role and is used mainly to determine position sizes.

The fund has looked pretty good so far in its first 16 months of existence; its returns have beaten the world large-stock Morningstar Category average and the FTSE All-World Index benchmark, and it has earned a Morningstar Sustainability Rating of High (5 globes). Expenses are low, as one would expect of Vanguard, which remains a topnotch parent. All this is encouraging, but the fund will need to deliver over a longer time period to earn an Analyst Rating higher than Bronze.

Process | Average

This fund uses a sensible process that integrates ESG considerations throughout. It's off to a good start, but its very short track record keeps the fund’s Process rating at Average.

The managers' stated goal is to outperform the fund’s benchmark (the FTSE All-World Index) by holding stocks that combine a high relative return on capital with good stewardship, which they believe can lower capital costs over time. Starting with an investment universe of 750 highly liquid global stocks, they use quantitative screens to narrow this down to 150 promising candidates, which they research intensively with the help of Wellington’s global industry analysts and ESG team. On the fundamental side, they focus on the sustainability of a company's returns on equity and the skill of its management at allocating capital; on the stewardship side, they look at each company's ESG priorities and willingness to engage.

The managers build a portfolio of 35-45 stocks out of the most attractive candidates. Position sizes are at least partly determined by valuation, with cheaper stocks getting larger positions; the managers also aim to keep the portfolio diversified by sectors, regions, and other factors. Formal limitations are few and fairly broad: sector weightings must be within 15 percentage points of the FTSE All-World Index benchmark, emerging markets can't be more than 20% of the portfolio, and cash can't be more than 10%.

People | Above Average

Mark Mandel and Yolanda Courtines have managed this fund since its June 4, 2019, inception. Although neither of them had managed a mutual fund before this one, they both had long careers as research analysts at Wellington before taking over here, and they draw on two topnotch analyst teams. The fund earns an Above Average People rating.

A Unique Choice for Income-Seekers

Mandel has been with Wellington since 1994, first as an analyst covering nonbank financials stocks, and from 2002 through 2017 as director of global research, overseeing Wellington's deep and experienced team of global industry analysts. In that role, he comanaged a separate account and three collective investment trusts that drew on his analysts' best stock picks. Courtines spent more than 20 years as an analyst covering Latin American and Eastern European banks, first for various sell-side firms and from 2006 for Wellington.

The analysts supporting this fund are among its most positive features. On the fundamental side, the managers are aided by Wellington's team of 53 global industry analysts, who average nearly 20 years of experience and have proved their mettle on other funds such as Vanguard Dividend Growth VDIGX. On the ESG side, they are supported by Wellington's 20-person ESG and sustainable investment team, which is larger and more experienced than most such teams at similarly sized investment shops.

Parent | High

The Vanguard Group entered a new era in early 2019 with the passing of its founder and conscience, John C. Bogle. Unlike its mid-1970s origins, when outflows were the norm and its survival was in question, Vanguard now wears the crown as the world's biggest retail asset manager. More than 90% of its USD 5.6 trillion in global assets under management, as of June 2019, are in the United States; but the firm has designs to grow its non-U.S. business, especially in the United Kingdom, Australia, Canada, Japan, China, and Mexico.

Vanguard gained its stature by following Bogle’s playbook: pairing relatively predictable strategies, both passive and active, with minimal costs. That’s enriched Vanguard’s investors, and those outside its flock who have benefited from industrywide fee compression. While Vanguard’s passive business now faces stiff price competition from its biggest rivals, inflows into its U.S. strategies still dominate.


Not content, Vanguard aims to transform investment advice, too. In May 2015, it launched Personal Advisor Services, a burgeoning discretionary asset-management business that pairs automation and human advice; and in September 2019 it disclosed plans to launch a digital-only counterpart. Vanguard’s industry leadership readily merits a High Parent rating, but the firm must stay on its guard to prioritize investor interests over merely expanding its kingdom.

Price

It’s critical to evaluate expenses, as they come directly out of returns. The share class on this report levies a fee that ranks in its Morningstar Category’s cheapest quintile. Based on our assessment of the fund’s People, Process and Parent pillars in the context of these fees, we think this share class will be able to deliver positive alpha relative to the category benchmark index, explaining its Morningstar Analyst Rating of Bronze.

Performance

This fund doesn't have much of a track record to evaluate yet, but it has looked pretty good so far in its short existence. From July 1, 2019, through Sept. 30, 2020, the Investor shares' 10.84% return beat both the world large-stock category average and the FTSE All-World Index benchmark by more than 2 percentage points, and its one-year and year-to-date returns through Sept. 30, 2020, beat about two thirds of the category. The fund held up pretty well in the bear market from Feb. 19 to March 23, 2020, when its 30% loss was 2 percentage points less than the category norm and the benchmark. Returns over such a short time frame don't mean too much, but the fund is off to a good start.

In its first 15 months of existence, most of the fund's excess return versus the category resulted from stock selection rather than sector weighting, which is consistent with the managers' goal. The biggest positive return relative to the category came from the industrials sector, with almost all of that coming from stock selection. Vestas Wind Systems (VWSYF) (up 90%), Danaher (DHR) (up 52%), Atlas Copco (ATLKF) (up 52%), and Deere (DE) (up 37%) were among the biggest industrials gainers in the portfolio over this period. As of June 30, 2020, Microsoft (MSFT) and Taiwan Semiconductor (TSM) were the only top-10 holdings from the FTSE All-World Index that were also in this fund's top 10.

Portfolio

As of June 30, 2020, the fund had 38 stock holdings, nearly all of them large caps. Software giant Microsoft and drugmaker Merck (MRK) were the two largest holdings. As of the same date, the fund had two big Morningstar sector overweightings relative to the world large-stock category: financials (by 11 percentage points) and industrials (by 6 percentage points). It was significantly underweight in communication services, consumer defensive, technology, and healthcare, plus energy, where it had no exposure.

In 2020's first quarter, the managers sold French oil company Total (the fund's only energy holding) and metal miner BHP, because the companies weren't moving in the direction of renewable energy as fast as the managers expected. To replace those holdings, the managers bought chemical company DSM, which is transitioning to animal health, and tire company Michelin, which is improving its sustainability profile.

As of Aug. 31, 2020, the fund had a Morningstar Sustainability Rating of 5 globes, with a sustainability score in the top 2% of its peer group. It also had the Morningstar Low Carbon Designation, with a very low Morningstar Portfolio Carbon Risk Score and Morningstar Portfolio Fossil Fuel Involvement. Those high ratings show that the managers have done a good job so far at holding the fund to high ESG standards.

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