it might be a surprise to some investors that not all environmentally oriented mutual funds are free of traditional fossilfuel companies but the pax high yield bond fund is living up to its esg—environmental social and governance—mandate when it comes to energy this year portfolio manager peter schwab completely weaned the 647 million fund ticker paxhx off fossil fuels—making it the only active highyield mutual bond fund without traditional energy holdings according to the fund there is a fossilfuelfree highyield passive exchangetraded fund ishares esg advanced high yield corporate bond  the combination of the fund’s lowerrisk profile and owning no fossil fuels has dragged on its yeartodate and oneyear returns schwab says as traditional energy yields improved and investors embraced more risk amid the economic recovery this year but the decision to cut ties with fossil fuels is a longterm one even though fossilfuel energy comprises nearly 15 of the widely followed ice bofa high yield index schwab believes the sector is too risky from both an environmental and investment standpoint the portfolio manager expects renewable energy to continue to take away market share from traditional energy as more of the global vehicle fleet electrifies and utilities shut down unprofitable coal plants to mitigate climate change while he is sanguine that decarbonization on this scale will take time he also says investors aren’t getting compensated for the risks they take holding highyield energy company debt most of these issuers are smaller companies in the fracking space with too much leverage he says “a smaller levered balance sheet mixed with a volatile commodity business like ep exploration and production just doesn’t work so well” says schwab 50 going further back the fund’s record is strong showing that esg funds can keep up with the pack pax high yield bond ranks in the top 27 of its highyield bond category on a fiveyear basis and in the top 30 on a threeyear basis with annualized returns of 62 and 67 respectively compared with its category peers the fund also is less risky while boasting aboveaverage returns during those time frames that’s because schwab who joined the fund in 2015 errs on the side of being conservative to achieve smoother returns in the long run the fund owns more bbbrated credits—higherrated noninvestmentgrade or junk bonds—and fewer of the riskier cccrated names—credits vulnerable to default—compared with its category and its benchmark and schwab does it while positioning the fund to take advantage of an economy transitioning to a more environmentally sustainable model “the idea is to try to identify businesses that we think are going to be more durable and frankly are in a good position to capitalize on a lot of these changes” he says to those who would say esg funds underperform because they shun certain sectors schwab points out that positive credit selection delivers the bulk of his fund’s performance rather than sector selection for instance to compensate for no longer having exposure to traditional energy schwab looks to sectors correlated somewhat to energy such as industrials and building materials he also will venture into the highly speculative tripleccc territory to pick up extra yield that the fund sometimes found in energy names the fund does however have a 10 cap on these riskier credits water infrastructure is an example of a substitute for traditional energy holdings schwab sees a strong need for municipalities and commercial entities to improve water infrastructure for both fresh water supply and sewer applications and increasingly for stormwater runoff management one example is mueller water products mwa which supplies water valves fire hydrants and monitoring and flushing systems the fund holds its 2029 bond with a 4 coupon another holding is a 2027 bond with a 5 coupon from advanced drainage systems wms the firm makes waterdrainage structures such as largescale piping retaining products and products for erosion control in 2017 high yield bought core  main cnm as a new issue it is a leading distributor of water sewer and fireprotection products at the time it was caa1ccc rated 2025 bond with a 6125 coupon although the company had a very high debt load core  main had a strong share in a growing market driven largely by municipal infrastructure spending to upgrade older water systems “we also like the ‘capital light’ nature of distribution businesses as they tend to generate strong free cash flow” schwab says noting the fund held the bond until it was recently called or repurchased by the firm to find opportunities schwab and his comanager kent siefers work closely with parent firm impax asset management’s inhouse esg analysts to integrate sustainability criteria into highyield credit research companies with higher esg risks aren’t automatically disqualified either schwab can add a name if the firm is trying to reduce material risks or is open to engagement to reduce problems but the esg analysts have the final say on what eventually enters the portfolio for now schwab remains cautious particularly as the economy is at a delicate juncture and the hunt for yield has driven up demand for junk bonds the covid19 pandemic continues to rage and the federal reserve might soon start tapering its bond purchases removing a layer of support for markets yet he knows returns may suffer if he doesn’t take appropriate chances as such he’s watching for higherrisk bonds from companies that could grow enough to handle high debt levels that said he’s also keeping a “tight leash” on lowerquality credits too “they look fine now” he says “but if they have trouble refinancing the markets might not be there when they need money”