Industry leaders team up for new ESG ETFs

Given its history in sustainable investing, TD Asset Management's launch of an ESG-focused ETF suite was a natural fit

Industry leaders team up for new ESG ETFs

In late 2020, TD Asset Management added to its growing lineup of ETFs by introducing three environmental, social and governance (ESG) solutions – its latest foray into responsible investing. Relying on its long history in this area, TDAM brought something new to the table by working with Morningstar to create the indexes the ETFs track and with Sustainalytics (a Morningstar company) to provide the ESG ratings for the securities in the funds. With the three industry-recognized leaders involved in the fund, TDAM is hoping it will influence investors and advisors who might still be on the fence about adding ESG mandates to their portfolios.   

“The ESG space is something TDAM has been involved in for a number of years, although it wasn’t always referred to as ESG,” says David Roode, VP and director of ETF product strategy at TDAM. “We were one of the first asset managers to sign the United Nations-backed Principles for Responsible Investing in 2008 and had a mutual fund at that time in sustainable investing. The mantra at TD is being the ‘Green Bank,’ so being in the ESG space is a natural fit.” 

TDAM has been making a strong push into the ETF market over the past couple of years. The company’s lineup has grown to 33 ETFs and, with $4.48 billion worth of assets as of January 5, is ranked seventh in the country for ETF assets, according to National Bank Financial Markets and the Canadian ETF Association

The company’s ETF shelf has grown by 27 products in the past two years (including 11 in 2020 alone), and amid the proliferation of ESG funds being brought to market, TDAM recognized a need for its own solutions. A desire to create something unique led to the formation of the TD Morningstar ESG Equity Index ETF suite, three funds that give investors exposure to main geographies around the world with an ESG tilt: Canada TD Morningstar ESG Canada Equity Index ETF (TMEC); the US, TD Morningstar ESG U.S. Equity Index ETF (TMEU); and International, TD Morningstar ESG International Equity Index ETF (TMEI).

“When we look at the strategy of the ESG suite, these are index funds that provide index-like exposure while incorporating ESG principles,” Roode says. “It allows investors to invest alongside their beliefs. They want to make a statement with their investments without sacrificing performance or exposure. The intent is these ETFs gain broad market-level exposure with the ESG tilt. It gives a core exposure for investors.” 

The construction of the funds and the indexes they track is anything but simplistic, which is why TDAM chose Morningstar to construct them. Since the funds need an ESG rating, having Sustainalytics provide that strengthens the construction. “We rely on Morningstar – they construct the index using a rating score provided by Sustainalytics,” Roode says. 

The process begins with the selection of a parent index, which represents the broad market of the geography where the fund is looking to gain exposure. Sustainalytics then provides data and scoring on the companies in that index, assigning each one a controversy score from 1 to 5, which measures issues companies might face and how they’re likely to deal with them. Anything with a high controversy score of 4 or 5 is automatically kicked out. In addition, controversial sectors like gambling, tobacco and weapons are excluded. From there, Sustainalytics provides ratings on the companies that are eligible and begins to build the portfolio.  

“We are left with a group of companies, and each has an ESG rating,” Roode says. “We rank those and build a portfolio, taking individual companies with the best ESG scores, and do that until we get the market cap of the companies included at 67% of the market cap of the parent index. We are getting the best ESG scores of the companies in the parent index. At the same time, we try and maintain sector allocation in the parent index.” 

The combination of Morningstar and Sustainalytics’ expertise is something Roode says make these funds unique, and the educational support they’ve received has been an added bonus.  

“The combination of TDAM as the issuer, Morningstar as the index constructor and Sustainalytics as the ratings provider works well,” he says. “They have a willingness to support the products and explain everything. Sustainalytics has helped put together education material – having that level of support in a space where there needs to be education of advisors and investors is important.” 

The trust factor created by the collaboration has also been key for TDAM. Roode says that because the ESG space is still in its infancy, having companies with experience to create the ratings and the indexes themselves was important.  

“We went through numerous companies that have a rating and use different methodologies,” he says. “It is still a bit of the wild West, and people don’t understand what an ESG score means – and they are not comparable between companies. When we looked to find an index provider to go with, we wanted to make sure we were collaborating with a firm that investors could trust. Sustainalytics, through our research, matched the criteria. They have been around for over 25 years, have roots in Canada, a depth of talent and a detailed process to evaluate companies.”

Having confidence in the quality of the research is critical – with so much information out there, Roode says, it would be nearly impossible for investors to evaluate it all themselves.

“Individual investors can’t look at and evaluate all the data points to ESG that Sustainalytics can – there are just too many companies,” he says. “When you are looking at ESG scores, you are looking not just at the financials – not all of it is numerical. They have a rigorous process to establish the scores that can be trusted. Their ratings are not relative; the scores are absolute, and that is an interesting element, which means you can compare across industries.” 

As more investors begin to place an emphasis on ESG investing, Roode believes TDAM’s new ETF suite will become a sought-after option.  

“Given these are index funds and provide broad market exposure, the intent is for people to get their core exposure in each of these various markets,” he says. “Investors can use them as their beta exposure and add other types of funds on the periphery.” 

On the other side of things, he notes that when advisors need to find a solution for investors interested in ESG, the backing that TDAM has put behind these ETFs makes them a trusted option.  

“As an advisor, you want to be able to trust what you are going into,” he says. “You want to know that it will achieve the objective of a high ESG factor while striving to provide market-like returns. That is why we did these funds with Sustainalytics because we can trust their ratings, the process and strength.” 


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