Sustainable Bottom Line: At least nine key factors should be considered when evaluating and choosing focused sustainable index funds, including various financial and non-financial considerations.
Notes of Explanation: The total net assets (AUM) of mutual funds with more than one share class have been combined. Trailing 12-month performance for mutual funds with multiple share classes reflect the performance of the best performing share class. Funds are displayed based on AUM as of March 31, 2026. Trailing 12-month returns are for the period ended March 31, 2026. Sources: Morningstar and Sustainable Research and Analysis LLC.
Observations:
• There are 151 focused (or labeled) sustainable index mutual funds and ETFs listed as of March 31, 2026. These consist of 176 funds/share classes with $167.0 billion in assets under management (AUM). The top 10 focused sustainable index funds, based on AUM, dominate the segment, accounting for almost 50% of sustainable index tracking fund assets. These funds, which include nine stock funds and one bond fund, range in size from $4.6 billion in AUM to $23.4 billion. Over the trailing twelve months, the 10 funds recorded rates of return ranging from 4.3% posted by the iShares ESG U.S. Aggregate Bond ETF to 45.7% achieved by the thematic First Trust NASDAQ Clean Edge Smart Grid Infrastructure Index ETF (GRID).
• Choosing a focused sustainable index fund involves investment, financial and non-investment factors that are just as relevant when considering conventional index funds, but these extend beyond conventional points to account for an investor’s sustainability preferences. The list below identifies nine key investment, financial and non-investment factors that warrant careful evaluation; however, investors may wish to assign different weights to some of these factors rather than treating them as equally important.
• Fund investment classification, category, or themes. Working to create a well-balanced asset allocation within an investor’s portfolio to manage volatility and optimize returns over time requires spreading index tracking (as well as conventional) investments across asset classes, categories and themes. Investments are classified into broad asset classes, such as stocks, bonds and short-term or liquidity. In each case, these may take the form of broad-based or more narrowly based securities or fund categories, for example, domestic (US) as well as international, and within international, developed markets or emerging markets while more narrowly based categories cover a range of styles based on market capitalizations, growth vs value, etc. Bonds and bond funds will be further classified according to their duration, credit quality, and liquidity. Also, thematic or specialized non-core positions may be added to a diversified portfolio or considered as add-on opportunistic investments. For example, the top 10 index funds fall into the following six classifications, categories or themes: funds investing in stocks that cover US large and medium cap stocks, US large, medium and small cap stocks, international stocks, emerging market stocks, as well as thematic stocks focused on smart grid and electric infrastructure. One fund invests in intermediate investment grade bonds.
• Fund size and liquidity. Larger funds typically offer better liquidity, tighter bid-ask spreads, lower tracking error, and greater operational stability. Smaller funds carry meaningful closure risk. Size also signals investor confidence and the fund’s ability to attract institutional capital.
• Expense ratio. Cost is one of the most reliable predictors of long-term returns. Expense ratios among sustainable index funds now range from a low of 0.03% to 1.99%, and that spread compounds meaningfully over time. For the ten largest sustainable index funds, expense ratios extend from a low of 0.03% applicable to the Vanguard FTSE Social Index I (VFTNX) to a high of 0.56% applicable to the thematic First Trust NASDAQ Clean Edge Smart Grid Infrastructure Index ETF. Lower-cost funds are generally preferable, all else being equal.
• Performance results and tracking error. An index fund’s absolute performance results will largely vary in line with its investment classification, category or theme. That said, its effectiveness should be evaluated based on relative and risk-adjusted performance, both against the fund’s stated benchmark and against relevant non-sustainable fund alternatives. Sustainable funds can diverge meaningfully from conventional indexes in certain market environments, and understanding those dynamics is important for setting realistic expectations. Another important and related consideration is the fund’s tracking error, a measure of how closely and consistently the fund follows its stated index.
• Securities lending. Virtually all large passive funds engage in securities lending to generate incremental income that offsets expense ratios. Investors should examine how much lending income is returned to the fund (Vanguard returns roughly 95%; iShares returns 81–82%), whether the fund lends fixed income securities as well as equities, what collateral standards are applied, and whether borrower default indemnification is in place.
• Application of sustainable investing practices. The idea is to match the fund’s approach with the investor’s own sustainability preference and priorities as closely as possible. Labeled funds may employ one or more sustainable investing approaches (refer to a listing of seven defined sustainable investing approaches), which is the case regarding nine of the top ten funds. The one exception is the thematic First Trust NASDAQ Clean Edge Smart Grid Infrastructure Index ETF which does not account for ESG factors and does not employ negative/positive screening or exclusionary strategies. Otherwise, the nine funds employ some combination of ESG integration, negative/positive screening or exclusionary screening and exclusionary approaches. That said, investors should be aware that within each of the sustainability approaches, variations are common and some variations may be subtle. For example, the iShares ESG Aware MSCI USA ETF (ESGU) seeks to track the performance of the MSCI USA Extended ESG Focus Index which maximizes exposure to companies with high ESG ratings in each industry sector. At the same time, companies involved with tobacco, controversial weapons, producers of or ties with civilian firearms, thermal coal and oil sands are not eligible for inclusion. At the same time, the Fidelity US Sustainability Index Fund (FITLX) tracks the MSCI USA ESG Leaders Index that is constructed, in part, by selecting constituents primarily based on criteria including the ESG rating, the trend in that rating and the company’s industry adjusted ESG score. In addition, exclusions from the index apply to companies involved in controversial weapons, nuclear weapons, civilian firearms, tobacco, alcohol, conventional weapons, gambling, and nuclear power.
• Investor pass-through proxy voting. An emerging and increasingly important variable is whether shareholders can exercise their proportionate voting rights on corporate governance matters through a pass-through or investor choice program. Currently, BlackRock offers this to institutional investors in its equity ESG ETFs, and Vanguard extends it to both institutional and retail investors in the Vanguard ESG U.S. Stock ETF. For sustainability-oriented investors, the ability to vote on resolutions related to climate, executive pay, and board composition can be a meaningful extension of their sustainability preferences.
• Portfolio reporting and transparency. ETFs typically disclose holdings daily while mutual funds do so on a quarterly or semi-annual frequency. Beyond holdings, investors in labeled or focused index funds should expect and seek out non-traditional metrics that describe the fund’s sustainability characteristics that enable investors to evaluate funds on certain environmental, social and governance characteristics. For example, investors concerned about climate specifically should seek out funds that publish carbon intensity metrics and implied temperature rise data. BlackRock Fund Advisors, the adviser to the six iShares funds in the list of the top 10 funds, offers some non-traditional fund metrics while Vanguard and First Trust do not.
• Management company. To ensure effective fund operations and instill trust and confidence in the organization, funds should be offered and managed by an established firm with a reputation for quality. Finally, sustainable investors may wish to consider the overall sustainability commitment of the fund manager and whether the firm votes its non-delegated proxies in a manner consistent with sustainable principles.
Sustainable investing defined
While there is no universally accepted framework and definitions continue to evolve, today sustainable investing refers to a range of overarching investment approaches or strategies. That said, many practitioners agree that these approaches encompass the following strategies that may be employed individually or in combination:
Values-based investing. Also referred to as faith-based investing, socially responsible investing, responsible investing, ethical investing or investing based on a set of morals, the guiding principle is that investments are based on a set of beliefs with a view toward achieving a positive societal outcome. Typically, this approach is executed using exclusions as well as negative/positive screening.
Negative/positive screening or exclusionary strategies. Negative/positive screening is the process of identifying companies or other entities that score poorly or highly on environmental, social and governance (ESG) factors relative to their peers and underweighting or overweighting these in investment portfolios. On the other hand, an exclusionary strategy refers to the exclusions of companies or certain sectors from portfolios based on specific ethical, religious, social, environmental or governance guidelines or preferences. Traditional examples of exclusionary strategies cover the avoidance of any investments in companies that are fully or partially engaged in gambling and sex related activities, the production or manufacturing of alcohol, tobacco or firearms, or even atomic energy. These exclusionary categories have been extended in recent years to incorporate additional considerations, for example, firms that are the subject of serious labor-related actions or penalties by regulatory agencies or demonstrate a pattern of employing forced, compulsory or child labor, or firms that exhibit a pattern and practice of human rights violations or are directly complicit in human rights violations committed by governments or security forces, including those that are under US or international sanctions for grave human rights abuses, such as genocide and forced labor. That said, it should be noted that significant policy shifts and investor sentiment are taking place in North America and Europe regarding the treatment of nuclear energy and the defense sector, driven by recognition of nuclear energy’s role in meeting the dual goals of energy security and net zero emissions while the war in Ukraine has been responsible for shifting the perception and interest among institutional investors in the defense sector.
Closely related is the strategy of divestiture or divestment. Divestiture strategies involve current holdings that are liquidated over time as their eligibility is no longer consistent with the owner’s objectives, such as fossil fuel companies. But divestiture strategies may also involve a much broader universe of securities, such as when for example, divestiture strategies were applied to apartheid practices in South Africa in the 60s and 70s. At that time, any company doing business with South Africa was taken off the list of eligible investments.
Impact investing. Still a relatively small but growing slice of the sustainable investing segment, impact investments are incremental (additional) moneys directed to companies, organizations, and funds with the intention to achieve measurable social and environmental impacts alongside a financial return. Impact investments can be implemented in both emerging and developed markets and made across asset classes, such as equities, fixed income, venture capital, and private equity. In each instance, the objective is to direct capital to address challenges in sectors such as sustainable agriculture, renewable energy, conservation, microfinance, and affordable and accessible basic services, including housing, healthcare, and education.
Historically, impact investments have targeted a range of returns from below market to market rate, depending on the investors’ strategic goals. But increasingly, impact investing strategies are expected to at least achieve risk-adjusted market rates of return.
A more widely practiced yet less rigorous definition of impact investing involves providing direct exposure to issuers or projects that managers believe have the potential to achieve social or environmental benefits.
Thematic investing. An investment approach with a focus on a particular idea or unifying concept, for example securities or funds that invest in solar energy, wind energy, clean energy, clean tech and even gender diversity, to mention just a few of the leading sustainable investing fund themes. Investing in low carbon emitting stocks and bonds or green bonds or funds also fall into the thematic investing category.
ESG integration. This is a widely practiced (some data suggests the most widely practiced) investment approach by which environmental, social and governance factors and risks are systematically analyzed and, when these are deemed financially relevant and material to an entity’s performance, they will influence decisions on whether to buy or hold a security, and to what extent. Such considerations may lead to the liquidation of a security from the portfolio but at the same time, these factors may also identify investment opportunities.
Shareholder advocacy, issuer engagement and proxy voting. These strategies, which leverage the power of stock ownership in publicly listed companies and, regarding engagement, the power of bond investments, are action-oriented approaches that rely on learning about each company’s ESG practices and related risks and opportunities. These strategies also extend to influencing corporate behavior through direct corporate engagement, filing shareholder proposals and proxy voting.
Structural sustainability. The scope for expressing sustainability objectives through security selection or ownership rights in money market funds is inherently limited by regulatory requirements and liquidity mandates. As a result, many sustainable money market fund offerings pursue sustainability objectives through structural mechanisms that operate outside traditional portfolio construction, such as inclusive intermediation practices (e.g., broker-dealer selection and distribution partnerships) and the allocation of adviser revenues to charitable or social purposes. In this analysis, such approaches are characterized as forms of “structural sustainability,” reflecting their focus on market processes and economic flows rather than on portfolio composition or issuer engagement.
Updated 3/25/2026
