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Maybe environmental, social, and governance, or ESG, investing is a sustainable strategy, after all.

Barron’s fourth annual ranking of big-cap equity mutual funds that received an “above average” or “high” sustainability rating from Morningstar shows that they outperformed comparable funds with lower sustainability ratings. The 189 actively managed funds that met those criteria returned 30% in 2019, just shy of the 31.5% that the S&P 500 index returned for the year. What’s more, 41% of the 189 funds beat the S&P 500—far better than the 29% of big-cap equity funds overall that beat the index, and up from the 39% of sustainable big-cap funds that beat the index last year.

Such outperformance could be coincidence, to be sure. After all, the practice of sustainability has pushed fund managers and investors into high-quality growth companies—exactly the kinds of stocks that have dominated a market where economic growth is sluggish and interest rates are low. The outperformance could also be fleeting: In 2019, according to Yardeni Research, S&P 500 operating earnings probably grew 1%, even though the index fetches 18.5 times consensus estimates for 2020. If and when overall earnings snap back, these funds could lag behind.

Still, the relative outperformance of ESG funds appears to be more than happenstance, says Jon Hale, the global head of sustainability research at Morningstar and the creator of the sustainability ratings. Plenty of intentionally sustainable managers added lots of alpha, or above-market returns, he notes.

Consider the Columbia Select Large Cap Growth fund (ticker: UMLGX), which ranked No. 6 on our list. “ESG is part of our toolbox and process,” says the fund’s co-manager, Tom Galvin. “Companies that are managing their financial controls well very often make intensive efforts to responsible and sustainable governance.” The fund was up 38% in 2019, handily beating the broader market.

This outperformance comes at a time when interest in sustainable funds is jumping. Net flows into sustainable funds were on track to triple their 2018 total through the third quarter, according to Morningstar. That included big offerings from iShares and Xtrackers, both based on the MSCI ESG USA Leaders index.

Meanwhile, a recent Morgan Stanley survey showed that 85% of U.S. individual investors are interested in sustainable investing, up by 10 percentage points from 2017. With such interest, expect more specialty funds to proliferate—offerings like the new exchange-traded fund (VEGN) and ETF (VETS).

The marketplace “will be like a big Target store at some point,” says Leslie Samuelrich, the president of Green Century Funds, which offers fossil-fuel-free funds such as Green Century Equity (GCEQX). “It used to be you’d buy Crest, Colgate, or Aquafresh toothpaste. Now there are 12 varieties. How do you choose?”

Here’s how Barron’s chose its funds: As in previous years, we looked at large-cap U.S. stock funds with assets of $300 million or more, and with at least one year’s performance. We also included exchange-traded funds and various factor-based funds. We took out funds based on common market indexes such as Invesco QQQ Trust (QQQ), which is based on the Nasdaq 100 index.

The Morningstar rating system we used to narrow the universe is based on how the underlying companies in the portfolio are rated by Sustainalytics, the ESG research and ratings provider that’s 40% owned by Morningstar. For comparison purposes, the widely held SPDR S&P 500 ETF (SPY) rates average, while we focused only on funds that rated high or above average on sustainability.

One other note: Starting in November, Sustainalytics adjusted its methodology to reflect its view that some industries, such as fossil fuels, have higher risks than others, such as software. In the past, Microsoft (MSFT) and Royal Dutch Shell (RDS.B) would have had similar ESG risk scores because their ESG practices were better than their peers.. The new scoring system reflects Shell’s higher risk as a fossil-fuel company. (For those who want to find out more about the funds, we’ve included a partial list on page 16, with the full list online.)

It’s also worth noting that the ranking goes beyond pure-play sustainable funds. How managers apply ESG isn’t standardized. Rules and practices concerning disclosure are still evolving, and many of the managers on our list don’t have mandates for sustainable investing, including most of the top 10.

But intentionality will increasingly matter, says John Streur, CEO of Calvert Research and Management, a sustainable-fund provider owned by Eaton Vance (EV). The world is pushing companies this way, through demand for sustainable funds as well as a newfound enthusiasm among companies to follow a purpose.

No. 1 on our list is Mark Mulholland, manager of the Matthew 25 fund (MXXVX). “I am not sure what ‘sustainable fund’ means,” Mulholland says. Mulholland does no ESG screening: He’s a fan of Range Resources (RRC), for example, on the theory that natural gas should replace coal. However, he also believes that “companies have multiple constituents” and can still serve investors’ best interest.

Mulholland runs the fund in a concentrated style, looking for companies with the potential to grow over the long term, and has a 20% turnover rate. He and his wife own more than 5% of the fund, which follows no religious principles but is so named because Mulholland finds the 25th chapter of the Gospel of Matthew inspiring. Among the largest positions: Goldman Sachs Group (GS), Apple (AAPL), KKR (KKR), Brandywine Realty Trust (BDN), and Polaris (PII), which together account for more than a third of the fund.

No. 2 is YCG Enhanced fund (YCGEX), run by the firm founded by Brian Yacktman, son of legendary contrarian investor Donald Yacktman. The fund isn’t managed for ESG, but seeks to benefit from behavioral quirks like overconfidence and short-termism, says co-manager Elliot Savage. “What leads to the high ESG rating,” he adds, “is we look for businesses that treat stakeholders well over the long term, that are win-win long term, and create net good.” Specifically, the fund looks for businesses with staying power, “with network economics, in an industry that doesn’t change a lot over time,” and growing at a rate that matches or beats growth in gross domestic product. Large positions include Mastercard (MA), Moody’s (MCO), CBRE Group (CBRE), Wells Fargo (WFC), and Aon (AON).

No. 3 and No. 4 are Valic Company I Large Capital Growth (VLCGX) and MFS Massachusetts Investors Growth Stock (MIGFX), very similar funds. Jeffrey Constantino, who manages both, says ESG is a “critical component” of the analysis of a business’s competitive position. “We don’t explicitly drive to a high ESG score or high sustainability. We have a long-term horizon and invest in businesses we think will be around for the long term,” he says. Both funds have zero energy exposure: “The world is moving toward greener solutions.” Large positions include Alphabet (GOOGL), Microsoft, Accenture (ACN), Visa (V), and Apple.

No. 5 is Eaton Vance Atlanta Capital Select Equity (ESEIX). Chip Reed of Atlanta Capital, a unit of Eaton Vance, looks for businesses with stable, consistent earnings over time but not necessarily an ESG focus. (Atlanta Capital also runs No. 11–ranked Calvert Equity [CSIEX], which does have a sustainability mandate.) Reed looks for companies with market caps over $3 billion, high returns on capital, competitive advantages, clean balance sheets, and healthy free cash flow. The fund likes large-caps such as Ball Corp. (BLL). Driving performance in 2019 was the age of the market cycle, says Reed. “Everyone was cautious because they didn’t see earnings growth. All these things played to quality and will continue into 2020.” Big positions include Fiserv (FISV), TJX Cos. (TJX), White Mountains Insurance Group (WTM), Teleflex (TFX), and Global Payments (GPN).

Last year’s No. 1, Polen Growth (POLIX), clocked in at No. 9 this year. “When we think of sustainability [risk], in terms of ESG, it’s anything that can get in the way of long-term earnings growth,” says manager Dan Davidowitz. Still, he’s relatively new to ESG: Polen began reading ESG analysis reports at the request of clients in Europe before last year’s rankings.

In many ways, all managers today are ESG managers, trying to quantify and reduce risk, looking at factors like quality of management, compensation, and environmental issues. But in a slow-growth world, the companies that many sustainable-fund managers look for, with durable franchises and practices, seem poised to keep running. “The way we define sustainability is an enduring competitively advantaged business model. Our good ESG scores are a result of our organic research,” says manager Bradley Klapmeyer of No. 12–ranked Ivy Large Cap Growth (WLGAX).

The jury on outperformance is still out, at least until our rankings have been through a full market cycle. For now, however, the evidence seems to be on the side of sustainability. “Companies expect it, employees and customers expect it, and from an investing standpoint, the information is now available,” says Joe Hudepohl, manager of Calvert Equity. “If you’re not paying attention, you’re ignoring a data point. And that’s something you can’t really afford to do.”

John Coumarianos contributed to this article.

The Top Sustainable Mutual Funds Barron's selected the top U.S. large-company, actively managed funds with the most sustainable portfolios, then ranked them by one-year returns. Of the funds, 41%, or the first 78 funds, beat the S&P 500 Index's 31% return in 2019. The ranking was based on data provided by independent research firms Morningstar and Sustainalytics. Total return as of Dec. 31, 2019. Three- and five-year returns are annualized. NA = not applicable. Source: Morningstar Direct, Sustainalytics

Write to Leslie P. Norton at leslie.norton@barrons.com