Evaluating ESG ETFs: Your Questions, Answered!
The downside of live webinars is that they never seem to last long enough! During Tuesday's "Evaluating ESG ETFs," Cinthia and I received some excellent questions—but far more than we could get to in a single hour. So, we are taking this opportunity to answer them here and now. (Questions have been lightly edited for space and clarity.)
If you missed Tuesday's webinar, you can still register and view the replay at any time.
So, let’s get to it.
When will there be a universal way of measuring corporate ESG scores? For example, Thomson Reuters and Sustainalytics have some companies at the top of their list that are at the bottom of the other's list. What's the best way to navigate this?
This is such a good question, and it's one ESG investors new and old wrestle with all the time. Who's to say which scoring methodology is the best?
Well, you are.
In the absence of standardized scoring metrics, your best bet is to peek under the hood of various data providers' methodologies—MSCI posts its version on its website, for example—and educate yourself on how ESG scores are calculated. Then, opt for the scoring system that you think makes the most sense. It's more homework, yes. But investing requires due diligence, and you should think of this as part of your ESG investing homework.
Has any ESG concept/segment shown outstanding performance thus far?
The obvious—but somewhat misleading—answer to this question is the Invesco Solar ETF (TAN), which has exhibited eye-popping 63% returns over the past 12 months. That type of performance isn’t unusual for this fund, actually. TAN’s supercharged returns made it our ETF Of The Week not once, but twice.
That said, TAN's a special case, because the ETF's brisk securities lending business has boosted its overall returns, big-time. That means there’s a huge community of traders buying up shares of TAN specifically to short them—not exactly a vote of confidence in the health of the solar industry, but one that shows up on performance.
However, one ESG concept that has exhibited significant outperformance is clean energy. The Invesco WilderHill Clean Energy ETF (PBW), the SPDR S&P Kensho Clean Power ETF (CNRG), and the ALPS Clean Energy ETF (ACES) are three such ETFs; each has delivered one-year returns above 60%.
Which ESG ETFs have the least exposure to fossil fuel companies?
Tricky question! That's because some ETFs historically marketed as 'fossil fuel free' are in fact fossil fuel reserves free, meaning that the companies in their portfolios hold no physical reserves of oil, gas, coal and so on. While that rules out oil and gas producers and coal miners, it fails to exclude other fossil fuel-dependent stocks, such as oil & gas industry service providers, pipeline operators and so on. It also doesn’t exclude significant consumers of fossil fuels, such as fossil-fuel-fired utilities. (Read more: "Fossil Fuel Free Funds That Aren't.")
That said, some ETFs do in fact use fossil fuel involvement as an exclusionary screen for constituents. An ETF's prospectus and other fund literature will make it explicit, but also As You Sow offers an incredibly powerful Fossil Free Funds tool that allows you to look up thousands of ETFs' and mutual funds' exposures to the fossil fuel industry.
Some lesser-known ESG ETFs that have zero exposure to fossil fuels include the Change Finance U.S. Large Cap Fossil Fuel Free ETF (CHGX), the KraneShares MSCI China Environment Index ETF (KGRN) and the Invesco CleanTech ETF (PZD).
Many companies don't report carbon intensity. Even fewer report energy or water efficiency. What's the best practice to deal with unknown data?
Unfortunately, there’s no easy answer here. Calling the data provider to see if they can work with you to get the information you need is your best bet; or, if you're in a position to do so, ask the companies directly.
It's a frustrating fact that specific ESG data is still irregularly reported, if at all. However, we're still in the early days of the “Big Data-fication” of ESG metrics. As an industry, the hope is that as ESG investing continues to grow and become mainstream, these metrics and more will become easier to publicly access.
Why invest in an ESG ETF, when you could just invest in several renewable energy stocks?
This goes straight to the existential thesis for ETFs: ETFs offer convenient, cost-effective exposure in an all-in-one wrapper. Trading an ETF that holds, say, 30 solar power stocks incurs much lower trading costs—that is, commissions and spreads—than you'd run up if you bought and sold those individual 30 stocks at once. It's also easier for you to invest in foreign stocks, such as Chinese or French solar companies, since U.S.-listed ETFs trade on New York hours, not on Chinese or European time zones.
For more reasons on what makes ETFs such a powerful investment tool, check out our ETF Basics module in the ETF Education Center.
What's the best vehicle for ESG investing? ETFs, separate accounts, etc.?
In an ideal world, you could argue that the best way to implement an ESG strategy is through active management or direct indexing. That way, you can get as granular as you want with your exclusionary screening criteria. Want to invest only in carbon-neutral companies that have no exposure to human trafficking or alcohol production? You aren't going to get that in an ESG ETF, at least not right now.
That said, we don't live in an ideal world. We live in a world where cost and convenience factors significantly into investment choices. The trading costs of such a highly customized stock-picking approach would be exorbitant, never mind the taxes or the total cost of ownership. Direct indexing doesn't offer much alternative; though innovation and scale are making the technology available to more folks every day, direct indexing is still only realistically cost-effective for a certain minimum asset base. Under that threshold, the additional cost premium and legwork likely outweighs any tax savings or customization that you or your clients might accrue.
For investors and advisors without hundreds of millions of dollars to invest, or who'd rather focus the bulk of their energy on more impactful financial decisions, an ESG ETF is a pretty darn good vehicle.
How is it possible to build a highly rated ESG portfolio without even using ESG funds?
It's possible because ESG scores are separate from ESG marketing. ETFs can—and often do—have ESG ratings without being explicitly marketed as an "ESG ETF." For example, the iShares MSCI United Kingdom ETF (EWU) boasts an AAA rating from MSCI, making it a very ESG-y fund. But the fact that it tracks UK stocks is probably the more meaningful factor for investors.
If you want to find out which ETFs excel in ESG rankings regardless of their naming convention or marketing efforts, it's as simple as going to our ETF Screener, selecting the "ESG" tab, then sorting ESG Ratings by ascending order.
As we discussed in the webinar, we also collect the 50 highest-ESG-rated ETFs into one handy list, another great place to start your research.
How do we know if a fund is "greenwashing"?
"Greenwashing," or the practice of funds marketing themselves as greener than they really are, is a persistent problem in ESG ETFs—one that's likely to grow worse as more issuers launch their own products and try to capitalize on a "hot trend."
To tell the green ETFs from the greenwashed ETFs, you've got to know what you own: Look under the hood of the ETF and ensure that its holdings are consistent with your expectations. Again, in this segment, there aren’t a lot of short cuts to thorough due diligence.
Can I create a portfolio on your site, then find the carbon intensity of that portfolio as a whole?
Not in a single step. However, you can find the average carbon intensities of each individual ETF in your portfolio right on their fund pages, or in the ETF Screener. (We talk about this in detail and show you how to do it on the webinar.)
Once you determine the weights you intend to assign each ETF, you can calculate a weighted carbon intensity for your entire portfolio by summing (CarbonIntensity_A * % Weight_A) + (CarbonIntensity_B * % Weight_B) and so forth.
Where can I find ESG scores of individual ETF holdings?
The data on ETF.com examines an ETF's overall characteristics, not those of its underlying individual constituents. But if you're curious about an individual company's ESG score, check out MSCI's ESG Ratings site. There you can look up a company's ESG score by name or ticker, as well as access a wealth of more granular environmental, social and governance assessments.
How can I check which new ETFs are ESG?
There are a few different ways to achieve that. Once an ESG ETF launches, it'll show up in our Socially Responsible ETF Channel, where you can track all sorts of metrics, such as its recent performance, cost, assets under management and so on.
You can also access this same information and much more, including fund flows, spreads and volume, via our ETF Screener. On the left-hand sidebar, under the heading "Popular ETF Channels," click on "Socially Responsible ETFs."
We cover all new ETF launches on our Daily ETF Watch section, so keep checking back regularly to learn about new funds; or sign up for our ETF.com Watch email newsletter to have filing and launch news regularly delivered right to your inbox.
Click here to watch the on-demand replay of the "Evaluating ESG ETFs" webinar.
If you have additional questions or would like to continue the conversation about ESG ETF investing, contact Lara Crigger at lcrigger@etf.com or Cinthia Murphy at cmurphy@etf.com .
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