ESG-focused ETFs can deliver better returns

One firm discovered that a strategy of investing in socially responsible ETFs paid off

ESG-focused ETFs can deliver better returns
In a victory for advocates of responsible investing, Sage Advisory Services has found that its ESG (environmental, social and governance) strategy was able to outperform its normal, ESG-agnostic strategy.
 
“We went and looked at our returns over the course of this year, and were able to demonstrate through the selection of ESG-oriented ETFs over non-ESG-oriented ETFs that we were able to outperform our normal strategy, our all-cap equity strategy, both on a gross and a risk-adjusted basis – not hitting that out of the park, but very much slightly ahead and for very similar cost,” said Sage president and CEO Bob Smith in an interview with Financial Advisor IQ.
 
Asked whether ESG investment would go against the planned fiduciary rule in the US that compels advisors to act in the best interests of their client – which are usually interpreted as financial – Smith said there’s no need to worry. “You don’t have to give that up. In their recent regulatory changes, [the DOL has] allowed ESG-oriented investments to be permitted and brought into the defined contribution world as qualified assets and a qualified asset or investment management choice.
 
Smith said the key to success lies in thor­ough screening – Sage looks at ESG funds as graded by research firm Morningstar. “We need to look at both growth and value, as well as international and domestic … [and] we generally will look for those that have $25, $50, $100 million or more in size as a qualifier [for liquidity, good two-way markets and reasonable cost in terms of bid-offer spreads],” he said.
 
“[And] we generally look for ESG scores of around 50 or higher,” he added, referring to Morningstar’s rating system. While the ratings are new, they are informed by global ESG assessment firm Sustainalytics. “They have 120 analysts all over the world who do nothing but provide assessments from an environmental, social and government standpoint … so that’s really the power behind it.”
 
 
Smith also noted that there are gaps in the universe of ESG-oriented ETFs. The small- and mid-cap spaces could do with a few more choices, he said, adding that Morningstar’s rating system applies only when a minimum peer group size of 10 funds is reached. He further pointed out that “there are no ESG-driven fixed-income ETFs … we would like to see more done in the fixed-income area.”
 

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