Environmental, social, and governance (ESG) ETFs are hot nowadays, both with investors and with issuers. There are now over 100 products on the market, which have collected some $31.76 billion in investment assets—overtaking assets invested in traditional energy ETFs for the first time.
But not every ESG ETF is—or even can be—a billion-dollar baby, and increasingly, the success of an ESG ETF comes down to the size of the issuer whose name appears on the label. iShares alone has seen $11.1 billion of the $14 billion in new net flows entering ESG ETFs year-to-date. (Read: "Demand Hot For iShares ESG Funds.")
As a result, many differentiated, thoughtfully constructed ESG funds that have failed to attract attention from investors, in part because their issuers lack BlackRock's marketing might or pool of BYOA cash. But that doesn't mean they aren't good opportunities.
We sorted through the ESG ETFs with fewer than $100 million in assets under management as of May 26, 2020, and pulled out some of our favorite hidden ESG gems.
Divest From Authoritarianism With FRDM
Emerging markets offer investors growth potential and diversification, but also an ethical quandary: How do you invest in developing economies without also funding authoritarian regimes?
The vast majority of emerging markets ETFs continue to invest significant amounts of cash into the same problematic countries—China, Russia, Saudi Arabia, Brazil and others—even as these countries crack down on their citizens' freedoms. The Vanguard FTSE Emerging Markets ETF (VWO), for example, invests 54% of its portfolio in China, Russia, Saudi Arabia and Brazil, while the iShares Core MSCI Emerging Markets ETF (IEMG), invests 47%.
But it doesn't have to be that way. The Freedom 100 Emerging Market ETF (FRDM) offers an alternative approach that's unique among emerging markets ETFs.
FRDM weights countries by their freedom levels, a nebulous-sounding concept that actually encompasses 79 separate metrics, touching on everything from a country's capital market structure and freedoms of its press to the extent of human trafficking within the country's borders. The top ten freest countries are selected, and the top ten largest, non-state-owned equities from those countries are included in the fund's index.
As a result, FRDM's portfolio has no exposure to China, Russia, Saudi Arabia, Brazil and other problematic countries, instead weighting heavily to Taiwan (24%) and South Korea (21%). Regionally, these countries' economies are tied to China's while still remaining distinct, thus providing FRDM with a slight cushion when Chinese stocks stumble.
For example, FRDM has outperformed VWO and IEMG over the past month by more than a percentage point, rising 3.6% compared to VWO's 2.4% and IEMG's 2.3%:
Source: ETF.com. Data as of May 28, 2020.
We'd be remiss if we didn't also point out FRDM won our award for the best new international ETF of 2019. (Read: "The Annual ETF.com Awards.")
Worried About Greenwashing? Try CHGX
One of ESG ETFs' most well-deserved criticisms, especially the broad market funds, is the issue of "greenwashing," or a seemingly lackadaisical approach to ensuring that the stocks in the portfolio actually adhere to the principles the ETFs purport to follow.
For example, many issuers have language in their funds' prospectuses about not investing in companies experiencing "severe business controversies," only to then include companies like Facebook (FB) or Amazon (AMZN) in their portfolios. (Facebook has blundered its way through privacy scandal after privacy scandal, while Amazon's record on labor rights is atrocious.)
The Change Finance U.S. Large Cap Fossil Fuel Free ETF (CHGX) isn't one of those funds. It's probably one of, if not the, most stringent ESG ETFs left on the market—an ETF made by true ESG believers, for true ESG believers.
CHGX is one of the few ESG U.S. equity ETFs where you won't find Tesla (TSLA), for example, nor Facebook, Amazon, Exxon (XOM), McDonalds (MCD) or Uber (UBER)—or any other company that has had significant labor, privacy or environmental controversies in its recent past.
That's because, unlike some ESG ETFs that try to simply limit, rather than eliminate, their exposure to certain objectionable themes, CHGX puts its money where its proverbial mouth is and divests entirely from problematic stocks and sectors.
Take its approach to fossil fuels. Not only does CHGX exclude oil and gas producers—as do many other ESG ETFs do—but it also excludes coal miners, oil and gas refiners and processors and utilities that burn fossil fuels. Compare that to the SPDR S&P 500 Fossil Fuel Reserves Free ETF (SPYX), which only excludes companies that have fossil fuel reserves on hand; or the ProShares S&P 500 Ex-Energy ETF (SPXE), which cuts out the entire energy sector but leaves in fossil fuel-consuming utilities (and everything else).
CHGX does tremendous legwork to ensure it isn't investing in companies whose business practices it defines as objectionable, without wildly impacting the overall sector break-down of its portfolio. For example, sector-wise the fund stays surprisingly close to the SPDR S&P 500 ETF Trust (SPY), for example:
Source: ETF Comparison Tool. Data as of May 28, 2020.
It's not an exact match, for sure. But with as many exclusions as CHGX makes, you'd expect its sector line-up to be more divergent than the broader market than it actually is, making CHGX a potential ESG "replacement" option for U.S. large cap exposure.
For Truly Unique Fixed Income Diversification: SPSK
Religious-based ETFs are not new, but until recently, most iterations on the theme have been Christian in nature.
Over the past few months, however, several Islam-based ETFs have launched, including the Wahed FTSE USA Shariah ETF (HLAL), the SP Funds S&P 500 Sharia Industry Exclusions ETF (SPUS), and the SP Funds Dow Jones Global Sukuk ETF (SPSK).
SPSK in particular is striking because it's a fixed income fund, and that may seem a contradiction in terms, as Shariah (the religious law underpinning Islam) prohibits the collection of interest on debt. As a result, Muslims aren't allowed to invest in the vast majority of bonds—which are debt instruments that make regular interest payments to their holders.
SPSK meets this challenge by instead investing in sukuks, which are Shariah-compliant financial certificates that grant holders partial ownership in an underlying asset.
Like bonds, sukuks still make regular payments to investors, but those payments aren't interest-based. They derive from the earnings the underlying asset generates—essentially, making sukuks profit-sharing arrangements.
Sukuks are a mainstay of Islamic finance, but they can be difficult for U.S.-based investors to access, as few i(f any) Western-based fixed income ETFs currently offer exposure to them and individual sukuks typically trade in over-the-counter transactions. So SPSK really is offering first-of-its-kind exposure to the market.
Plus, with performance that tends to look nothing like that of the bond market and exposure to Middle East and North African countries not typically covered by bond indexes, SPSK also offers real diversification to a fixed income portfolio—something that earned it the ETF.com award for the best new international fixed income ETF of 2019.
Source: ETF.com. Data as of May 28, 2020.
Is there an ESG ETF that you feel hasn't gotten enough attention? Write to us about your favorites at email@example.com.
Contact Lara Crigger at firstname.lastname@example.org