ESG ETFs may need to reach a critical mass before their assets explode
Environmental, social, and governance (ESG) investment may be primed to hit the spotlight. Due in part to the increasing importance of ESG integration and a tightening focus on thematic investing, the markets may be more ready than ever to embrace the idea of investing not just for profit, but also in alignment with values.
But looking at the performance of ESG ETFs relative to their hype so far, the prospects of an immediate takeoff seem very limited. A recent report noted that out of 65 ETFs classified as “socially responsible,” less than a fourth have seen clear success.
“[O]nly one has broken US$1 billion in assets under management … Fourteen others have topped $100 million in assets, a common liquidity threshold that many investors use to gauge a fund’s seaworthiness,” said ETF.com. “That’s just 15 ETFs in 13 years, together totalling less than $5 billion in assets.”
One factor stunting ESG growth in ETFs, according to CFRA Director of ETF and Mutual Fund Research Todd Rosenbluth, is the category’s massive popularity among mutual funds. “ESG mutual fund assets have been quite sticky, even as most actively managed mutual funds slowly bleed assets in favor of passive, index-based ETFs,” he said.
Recent data from McKinsey & Co. shows US$22.89 trillion in assets worldwide invested according to ESG principles. ESG ETFs account for only uS$4.8 billion in AUM — less than 0.02%.
Rosenbluth asserted that ESG investors are driven by the values of their conviction; they can tolerate more underperformance and active management costs than the average investor, and therefore are less prone to switch to ETFs. But that’s just one theory.
“People have been asking for years, ‘Where are the [ETF] assets?’” said Sarah Lee Kjellberg, director and head of US iShares sustainable ETFs. “My question is, ‘Where are the products?’”
Kjellberg said the first ESG ETF launches in the US were followed by more than a decade of minimal growth in the space; zero new ESG ETFs were launched in 2010, 2011, and 2013. But then in 2016, 22 ESG ETFs were launched, and new net inflows into the space more than tripled. Another 18 launches followed in 2017, coinciding with a 39% year-over-year rise in net inflows to reach more than US$1.6 billion.
Of course, investors are not likely to scramble immediately into ESG ETFs. Among the 15 largest ESG ETFs, only one was launched in 2017, according to ETF.com; almost half are at least five years old, and most took several years to cross the critical US$100-million mark.
Small as it is, the ESG ETF space presents a more level playing field than the ETF industry at large. While Vanguard, BlackRock, and State Street have cemented themselves as the big three of ETFs, ESG funds by Guggenheim, Global X, and WisdomTree have gained significant assets.