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A Closer Look at Vanguard Global ESG Select Stock

Jon Hale, Ph.D., CFA (jon.hale@morningstar.com)

You know that sustainable investing has entered the mainstream when Vanguard steps up its game.

In September, the firm launched two exchange-traded funds, Vanguard ESG U.S. Stock ETF ESGV and Vanguard ESG International Stock ETF VSGX . The two have already grown to $417 million and $270 million in assets, respectively. I commented on the funds here. The firm had been in the ESG space for years with a single fund:  Vanguard FTSE Social Index VFTSX launched in 2000, has $5.6 billion in assets, and earns a Morningstar Analyst Rating of Silver.

In March, Vanguard filed for the launch of its first actively managed ESG fund, Vanguard Global ESG Select Stock VEIGX, to be run by Wellington Management, a long-standing Vanguard subadvisor that manages more than $350 billion in various mandates for the firm.

Vanguard announced this week that the fund is now available for investment in a two-week subscription period concluding on June 4, 2019, when the fund will actually begin trading and will continue to be open to investors.

What is a subscription period? It's a chance for investors to buy in to the fund before it starts trading. Their money is placed in money market instruments even though they'll be paying the full expense ratio during this time. Vanguard says this helps the fund accumulate enough assets to construct a portfolio and reduce initial trading costs on day one of the actual fund launch. In 2017, Vanguard held a subscription period prior to the launch of  Vanguard Global Wellington  VGWLX that raised $341 million.

Does a subscription period actually benefit investors? I don't see how. A new fund is unlikely to have a big runup on the first day of trading the way stock IPOs sometimes do, so it isn't necessary to get in on the ground floor. Vanguard could easily seed the fund itself to assure efficient portfolio construction and reduce initial trading costs. Moreover, the plan is for the portfolio to have only around 40 names, all of them likely to be large, very liquid stocks. The only advantage I can see for investing during a subscription period is if there were some chance that a fund would take in so much money that it would close to new investors before it even begins trading. A fund like this one would need to take in billions to hit capacity. Not going to happen.

In any event, the fund is likely to draw a lot of investor interest before or after the subscription period, so let's take a closer look at the soon-to-be-launched Vanguard Global ESG Select Stock.

According to the original filing, the fund will focus on companies Wellington believes "demonstrate exemplary long-standing ESG practices and have strong business fundamentals and management teams with proven track records of good capital allocation decisions for shareholders." The fund expects to hold stocks over "an extended time horizon, resulting in low portfolio turnover." Wellington will be responsible for shareholder-engagement activities and proxy voting.

I like the ideas of Wellington being in charge of engagement and proxy voting and of a compact low-turnover portfolio. Too many active managers water down their portfolios with weak-conviction stocks. That tendency can especially work against ESG portfolios, which often end up looking not terribly different from conventional ones. As a sustainable investor, I also like the idea of a long-term-oriented portfolio of high-conviction stocks of companies that are committed to sustainability. While its ESG work has been largely under the radar, Wellington is a top-quality manager that can be expected to implement ESG in a thoughtful way. It has already integrated ESG analysis firmwide.

What the Portfolio May Look Like
For more insight into what the new fund may look like, Wellington Global Stewards offers a few clues. Launched in January and available to European investors, the fund is comanaged by Mark Mandel and Yolanda Courtines, who will also comanage the Vanguard offering. I expect the Vanguard fund will be a virtual clone of this one.

Wellington Global Stewards is a global large-cap equity portfolio, consisting of companies the managers consider to be "global stewards." They define stewardship as "every aspect in which companies are accountable to their stakeholders for long-term growth, including material environmental, social, and governance ("ESG") factors, although it does not necessarily mean that the core business of the company is ESG related."

According to its Monthly Factsheet, via Morningstar Direct, the fund had 38 holdings at the end of April. Relative to its  MSCI All-Country World Index benchmark, the portfolio is overweight in Europe, and underweight in Japan and emerging markets. From a sector perspective, it is underweight in energy, communication services, and consumer staples, and overweight in consumer discretionary and industrials.

While we don't yet have access to its full portfolio, we do have a list of Wellington Global Stewards' top 10 holdings. These names generally consist of companies with low levels of overall ESG Risk according to Sustainalytics. In addition, the top 10 holdings generally have lower levels of ESG Risk relative to their industry peers.

On a scale ranging from 0 (low risk) to 50 (high risk), seven of the top 10 have ESG Risk Ratings below 20, which Sustainalytics classifies as "Low ESG Risk." Two more have ESG Risk Ratings just above 20. The only exception is  Novartis NVS , at 30.3, which Sustainalytics assesses as a "High ESG Risk" company, owing to product governance, business ethics, and bribery and corruption issues. Nevertheless, Novartis has lower ESG Risk compared with other pharmaceutical companies, ranking in the best quartile. That means it is managing its ESG risk at least somewhat better than most of its peers. On average, the fund's top 10 holdings rank just outside the best decile relative to their peers when it comes to overall ESG Risk.

Relative to its benchmark, the MSCI All-Country World Index, the fund's top 10 holdings have about 20% less ESG Risk than the top 10 holdings in the Index. Relative to peers, the index's top 10 holdings rank in the middle of the pack, in the 45th percentile. The two portfolios share only two names among their top 10s:  Microsoft MSFT and  Visa V .

How do the Wellington Global Steward holdings stack up against an ESG benchmark?MSCI has two versions of ESG indexes based on the MSCI All-Country World Index: the MSCI ACWI ESG Universal Index and the MSCI ACWI ESG Leaders Index. The universal index reweights the ACWI by tilting toward better ESG performing companies and away from worse-performing companies. The leaders index, by contrast, targets the highest-rated ESG companies while maintaining sector and regional weightings similar to the ACWI.

Based on a comparison of top 10 holdings, those of Wellington Global Stewards have considerably lower ESG risk and better relative-to-peer rankings than those of the MSCI ACWI ESG Universal Index. The two share only one holding among their top 10: Microsoft.

Compared with those of MSCI ACWI ESG Leaders Index, Wellington Global Stewards' top 10 holdings have just slightly lower overall ESG risk and better relative-to-peer rankings. The two share only two holdings among their top 10: Microsoft and Visa.

The Vanguard Cost Advantage
It should come as no surprise that Vanguard Global ESG Select Stock will come with a cost advantage. Its Investor shares (minimum initial investment: $3,000) are estimated to have an expense ratio of 0.55%. That's half the 1.12% average expense ratio for share classes open to everyday investors at low minimums among actively managed ESG funds in the world large-cap Morningstar Category. And it's not much more than the 0.41% average expense ratio of passive ESG ETFs and open-end funds in the category.

One caveat I have about the fund is that while comanagers Mandel and Courtines have years of portfolio management experience, Wellington Global Stewards appears to be their first serious dive into ESG investing, and that fund is less than four months old. While that's the main risk to investing in Vanguard Global ESG Select Stock upon its inception, the fund does have a lot going for it out of the starting gate, including low fees, a quality subadvisor, and what appears to be well-conceived approach to ESG. I expect successful asset-gathering over time if not during the subscription period.