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TrackInsight: ESG ETFs – The Ultimate Guide

04/29/2021 | 09:59am EDT

ESG investing is one of the highest-growth areas of the global ETF industry and is rapidly transforming from a niche to a core investment.

You might’ve heard of the term ESG or ESG ETFs in conversations about sustainable investing. In this guide you will find everything you need to know about ESG ETFs:

  • What are the different types of ESG ETFs?
  • What should you consider before buying ESG ETFs?
  • How can ESG scores help investors?

What are ESG ETFs?

ESG ETFs seek to include Environmental, Social, or Governance goals into their investment strategy.

These goals can vary greatly, but most ESG ETFs seek to address the ‘E’ – Environment, with concerns like lowering carbon emissions, investing in green energy production or electric vehicles.

The ‘S’ – Social, focuses on ideas that include ethical considerations like gender equality, supply chain treatment, anti-slavery.

The ‘G’ – Governance, considers how well a company is run and managed and seeks to avoid companies that may be corrupt, poorly run or carry a high reputational risk.

ESG investing is one of the highest-growth areas of the global ETF industry and is rapidly transforming from a niche to a core investment in many professional and personal investors’ portfolios.

Figure 1.0 – Environmental, Social and Governance criteria

The breakdown of ESG ETFs based on criteria. Environmental, Social and Governance also known as ESG.

Source: CFA Institute

What Are the Different Types of ESG ETFs?

ESG ETFs can be very broad and include companies from many countries and sectors, or they can focus on a narrow ESG theme (for example, Solar Energy).

Because there are many different types of ESG ETFs, we group them into four categories based on how they determine which companies to include or exclude.

Exclusion

Exclusionary approaches exclude companies or industries that do not meet minimum standards of sustainability based on international norms – often weapons manufacturers, tobacco companies or fossil fuel producers.

Best-in-Class

Best-in-class approaches select the most sustainable companies from each sector. In this approach, the ETF might still invest in fossil fuel companies or tobacco producers, but they will be limited to the ‘best’ companies for ESG in each sector.

Full Integration

Full integration approaches can implement both positive and negative screening but what makes them distinct is that they go one step beyond. They integrate ESG at every step of the way and can give more weight to the companies that are ESG leaders and less weight to the companies that need to improve.

Thematic

Thematic ESG ETFs focus on one specific sustainability theme, for example clean energy, sustainable food or gender equality.

If you want to explore the ESG ETFs available in your region, please visit TrackInsight ESG Observatory.

What Should You Consider Before Buying ESG ETFs?

Sustainable investing is growing fast as many investors want to see their money contribute to making the world a better place.

There are now hundreds of ESG ETFs that cover different sustainability themes, so what should you look at before you decide which is right for you? We look at four things to consider.

What goal are you trying to achieve?

It’s key to understand why you are investing in an ESG ETF and how it will fit into your portfolio. Will the ESG ETF replace an existing fund, or will it be an addition? Will it focus on a specific region, sector or theme?

Given the broad range of approaches, it’s not always easy to compare funds. One of the solutions to make sure your investment will help address the issues you are concerned about is to select ETFs aligned with the UN Sustainable Development Goals (SDGs). Based on globally recognized standards, the SDGs promote tangible and meaningful global outcomes and provide an excellent reference point to judge the impact of investment choices.

See the SDG-aligned ETFs that are listed in your region.

Does the approach of the ETF match your ideas of ESG?

Broad market ESG ETFs tend to be slightly more expensive than similar non-ESG ETFs, but there is still competition to provide great pricing. Make sure you are comparing the ETF with similar funds to see if you are getting good value for your investment. Trackinsight provides simple tools you can use to make these comparisons.

Who is the issuer?

You might also want to look at which company provides the ETF to see if their business practices and philosophy align with your ideas of ESG. Do they use their power as shareholders in companies to create positive change, or are they less engaged?

Want to know more? TrackInsight’s ESG Observatory helps you explore the ESG ETFs available in your region and offers straightforward ESG ratings to help you find the ETF that matches your sustainable goals.

How ESG Scores Can Help Investors

Investors selecting ESG ETFs might find ESG scores helpful. With a single letter from A to D, ESG scores sum up all available information on the ETF’s sustainability characteristics and help investors save time and make the right investment decision.

Who provides ESG scores?

There are more than 125 ESG data providers[1] around the world striving to impose their own ESG methodology as the industry standard. The ESG data sector has recently seen an increase in acquisitions by industry giants. Morningstar, S&P, Solactive, Factset, Nasdaq and Moody’s all bought specialized vendors over the past two years[2]. By contrast, MSCI has its internal research team calculating their ESG scores, which is then used by its own index products and Bloomberg Barclays Fixed Income indices range.

Each ESG data provider has its own metrics to identify what are ESG matters. They source this data differently too. Most of them get the data directly from public sources such as companies’ reports. Some also conduct interviews with the stakeholders or send questionnaires. Some even claim to be able to capture the unstructured ESG data with Artificial Intelligence technology. After collecting this data, ESG scores providers categorize and weight them with their proprietary in-house process and eventually put together a final ESG score.

ESG ETFs score better on average but there are exceptions

We looked at more than 200 ESG ETFs and assessed their ratings versus their closest peers. We identified similar funds using our novel peer-finder tool (coming soon for all Trackinsight users!). On average, we managed to identify more than 100 peers for each ESG ETF.

And we found that, on average, ESG ETFs rate better than 78% of non-ESG peers, while 15% of ESG ETFs rank the same.

How do ESG ETFs score against non-ESG peers?

Source: TrackInsight, ESG scores based on Conser methodology, averages over 216 ESG ETFs, data as of 31st Dec. 2020.

However, like investors, we worry about greenwashing. So, we looked at the fine print of our study. If the average data is representative of the group, there are still some specific ETFs that need to be investigated separately.

Among the ten largest ESG ETFs, there are two US equities ETFs scoring C+. This score is rather average and perhaps below what investors would expect of their ESG ETFs. Among their peers, some ETFs have a B+ score (better by three ranks). Interestingly, those ETFs focus on style factors such as Quality or Growth. As intriguing as it is, this remains anecdotal evidence and we cannot conclude that factor ETFs are inherently scoring better in terms of ESG criteria.

Some ESG strategies score better than others

As our study finds, not all ESG strategies are made equal. Different types of ESG ETFs get different sustainability scores. Once again, we compare ESG ETFs with their non-ESG peers. This time though, we are looking to assess grade improvement by type of ESG strategy.

As shown in the chart below, on average all ESG strategies yield better ESG scores than non-ESG peers. Still, one ESG strategy is lagging behind the group. With ratings equal or worse to close to more than half of their peers on average, exclusion screening seems to be a less effective strategy in terms of mitigating ESG risks.

How do ESG ETFs with different ESG strategies score against non-ESG peers?

Source: TrackInsight, ESG scores based on Conser methodology, averages over 216 ESG ETFs and 2000+ peers, data as of 31st Dec. 2020.

This difference between strategies is also illustrated when looking at improvements in ESG scores.

Funds adopting the exclusion screening barely improve ratings versus their non-ESG peers. This makes sense as the strategy is the one with least modifications in portfolio holdings. This “soft” approach to ESG, merely removing the ESG laggards, cannot match shifting the investment approach to fully fulfil ESG principles.

By contrast, the best-in-class strategy seems to be the approach that delivers the most difference in terms of ESG scores. Not only do ESG ETFs with this strategy have a better rating, on average, than 95% of their peers, but they also see the largest increase in ESG scores. This means they score better than most peers, and by a significant amount. While their peers score C+ on average (corresponding to a grade of 6 on the graph below), best-in-class ESG ETFs rank A- on average. That is a four-rank improvement!

How much do ESG strategies improve ESG Scores?

Source: TrackInsight, ESG scores based on Conser methodology, averages over 216 ESG ETFs and 2000+ peers, data as of 31st Dec. 2020.

Why we believe a consensus-based score is best

Can investors avoid buying controversial ESG products? We believe consensus-based approaches can help investors in their ETF selection. Those approaches are based on the ESG experts’ average opinion on a company and the divergence (or convergence) of those opinions.

By choosing to use a consensus score, investors benefit from the insights of the whole industry instead of limiting their scope to a single house’s ESG philosophy – which might not be in line with the rest of the industry.

At TrackInsight, we provide consensus-based ESG scores designed by our partner Conser, a Swiss-based independent ESG verifier, on more than 3,500 ETFs worldwide. TrackInsight’s screener makes it possible to filter the universe by ESG score or specific impact goals (United Nations’ Sustainable Development Goals). ESG opinions on ETFs holdings are displayed on each fund’s page (see screenshot below).

ESG consensus analysis by Conser - ESG ETFs

Source: TrackInsight

Conclusion

Claiming to be ESG is no longer enough. Investors deserve to get what they pay for and funds that are engaging in greenwashing deserve to be called out. Fortunately, investors now have the tools and information needed to evaluate, compare and see for themselves which fund best suits the sustainable goals they are aiming for.


[1] Source: Bloomberg Webinar – The Future of Sustainable Investing [2] Source: The ESG Data Challenge (ssga.com)

© www.trackinsight.com 2021
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