The performance of environmental, social and governance (ESG) funds has been unimpressive, according to new research, and the occasional outperformance is driven mainly by funds’ expenses, exposures to certain industries and factors. Advisors should adjust their due diligence to reflect those findings.

The popularity of ESG investing – it now accounts for more than $12 trillion (according to the Global Sustainable Investment Alliance), one out of every four dollars under professional management in the United States and one out of every two dollars in Europe – has been accompanied by heightened research into the subject, with more than 1,000 research reports published. Jan-Carl Plagge and Douglas Grim, of the research team at Vanguard, contribute to the literature with their study, “Have Investors Paid a Performance Price? Examining the Behavior of ESG Equity Funds,” which appeared in the February 2020 issue of The Journal of Portfolio Management.

Plagge and Grim investigated the performance characteristics of investable ESG equity funds to understand the key drivers of their performance. The dataset comprised both index and active equity mutual funds and exchange-traded funds with a U.S. investment focus that indicates the use of ESG factors in their investment process. They studied the 15-year period 2004 through 2018.

Their selection of ESG funds follows Morningstar’s sustainability rating strategies. They removed from their sample all funds with an industry-specific investment focus – they assumed the characteristics of these funds are mainly driven by industry-specific rather than ESG characteristics. As evidence of the increasing popularity of ESG investing, their empirical dataset began with a total of 98 funds and gradually increased over time to a total of 267 funds by the end of 2018. Of these 267 funds, 51 were index funds and 216 were active funds.