ETF issuers are catching the ESG wave

New ESG ETFs are making values-based investing easier, though there are some critical caveats

ETF issuers are catching the ESG wave

Just a few years ago, ESG represented just a small sliver of the strategy of universes within the ETF space. But new figures from industry data providers and financial firms show that change is afoot.

“Globally, there are now around 182 ETFs that incorporate environmental, social and governance factors into their investment strategies,” said a report by the Wall Street Journal, citing the most recent data from FactSet. Those ETFs hold about US$20.7 billion in assets under management, and 59 of them were launched in 2018 or 2019.

Contributing to that total is about US$180 million of inflows into ESG ETFs during the first two months of the year, according to Morningstar’s Director of Sustainability Investing Research Jon Hale.

“The overall size of this universe remains small, however, and many of the new funds may have seed money or dominant institutional investors,” Hale told the Journal.

That trend also aligns with investors’ recent rising interest in ESG investing. Investors in Europe and the US in particular have recently shown particular interest in socially responsible ETFs for fixed income, according MSCI Head of ESG Product Eric Moen.

“We are seeing demand for ESG fixed-income ETFs expand from mainly investment-grade asset-class indexes to interest in high-yield and emerging markets,” Moen said. He noted a pickup in momentum among fixed-income ESG funds, with 12 out of the 15 launched in 2017 and 2018.

One of the hurdles to ESG ETFs has been premium pricing. Rosenbluth said that providers initially set higher prices in consideration of the uniqueness of the strategies, as well as a hope that investors would pay for the privilege of investing according to their values.

Such ETFs tend to cost more than their market-cap-weighted counterparts even now, but Hale pointed out that providers are dialling down prices to make ESG products more competitive. Last September, US investors witnessed the launch of the Vanguard ESG U.S. Stock ETF and the Vanguard ESG International Stock ETF, which came with expense ratios of 0.12% and 0.15%, respectively. In March, the Xtrackers MSCI USA ESG Leaders Equity ETF was debuted with an expense ratio of just 0.1%.

“By making them so competitively priced, the companies are hoping to take the price differential off the table and allow investors to make more apples-to-apples comparisons,” Rosenbluth said.

Some observers point to critical caveats. One involves the question of fund performance, which Rosenbluth said could be hurt by negative screens that exclude market-leading stocks from companies with poor ESG records. Still, there has been evidence to indicate that ESG-oriented strategies can perform well, and that investors are willing to sacrifice some of their returns to invest in accordance with their convictions.

Another potential issue is the lack of consistency in the values emphasized by ESG ETFs, or on how values are implemented in security selection and weighting.

“Reliable metrics for corporate behavior can be hard to come by,“ said Elisabeth Kashner, director of ETF research at FactSet. “Worse, expectations can vary by industry. There is no industry agreement on how to measure even the most common ESG criteria.”


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