Since its inception circa 2005, ESG investing has been deemed a socially responsible means of engaging the capital markets. Behind the idea of promoting sustainable investing by addressing "environmental, social and governance" (ESG) issues, ESG strategies have exploded in popularity over the past decade.
Like any other investment strategy, buying and selling ESG funds, stocks and exchange-traded funds (ETFs) has its own process. Read on to learn more about how to invest in these financial products.
What Is An ESG ETF?
ESG ETFs are exchange-traded funds that feature companies that adhere to specific environmental, social and governance values. The first ESG ETF was launched in the early 2000s. Since then, the sector has grown in popularity, attracting investors from all walks of life.
As of November 2021, there were 834 globally listed ESG ETFs with a combined US$361 billion in total assets under management. Many of the assets included in these offerings either directly or indirectly focus upon a few vital values: climate change, equality and corporate governance.
The challenges posed by climate change are a basic tenet of ESG investing. Key sectors include renewable energy, conservative management of natural resources as well as carbon neutral providers of goods and services. In fact, clean energy ETFs make up a significant portion of the ESG space.
Addressing societal concerns plays a major role in ESG investing strategies. Ideal stocks for inclusion in ESG ETFs are those that promote social diversity in management, corporate values and capital investment.
The way that a company is managed is an important part of it being viewed as an ESG ETF candidate. Diversity in leadership, as well as how the company tends to the needs of stakeholders, employees and customers is a crucial aspect of a firm being part of the ESG sector.
As with all other ETFs, ESG products aim to secure consistent growth and robust total returns. However, instead of being 100% bottom line oriented, core principles actively dictate investment objectives. This runs contrary to a traditional commodity or stock ETF that views responsible investing as being centred on generating value for its stakeholders.
Getting Started With ESG ETFs
In order to be a savvy ESG investor, due diligence is required. Like in all other investment decisions, it's crucial to have an understanding of an ESG ETF's capital allocation, who the principal issuers are and fee structure.
Before putting money into mutual funds, an index fund, bond ETF or ESG ETF, some basic research is necessary. It's best to begin with a look at the product's official prospectus and benchmark ratings.
A prospectus is the legal document that a company files with a regulatory body to ensure that it is on the up and up. ETFs are also required to issue a prospectus to clearly define the basic tenets of the fund. In the United States, these documents are filed with the U.S. Securities and Exchange Commission (SEC).
By viewing an ETF's prospectus, the investor will learn about the investment objectives, fees and risks involved in the fund. While not investment advice, the prospectus furnishes individuals with a view of how the ETF is managed. Here are two important items every investor can learn from an ESG ETF.
The costs and fees associated with investing in the ETF are outlined in the prospectus. Ideally, the fund is a low-cost way for ESG investors to allocate funds to the asset class. One of the ways ETFs place cost into context is with the expense ratio. An expense ratio is the cost of owning a mutual fund or ETF. It is expressed as a percentage of invested capital in the fund. Generally, the lower the expense ratio, the more efficient the investment.
The disclosure offers information on the ETF's past performance, investment strategy, diversification, capital structure, risk and projected future results. By studying these metrics, investors can decide whether or not the fund promotes adequate ESG factors.
Like all other investments and asset classes, ESG ETFs are rated on a continual basis. This is done in a variety of ways, one of which is the actual assignment of ESG scores to individual offerings.
An ESG score is a grade that evaluates how sustainably a company is conducting business. ESG scores are calculated according to how efficiently publicly traded companies are meeting ESG metrics. This is an important element for sectoral ETFs as assets included in the fund must satisfy the strategy's foundational tenets.
One purveyor of ESG ratings is MSCI USA. The MSCI ESG is designed to "measure a company's resilience to long-term industry material environmental, social and governance risks." The MSCI ratings range from leader (AAA, AA), average (A, BBB, BB) to laggard (B,CCC). Tools used to build the ratings include climate and emissions research, as well as management and societal factors.
ESG scores are often key considerations when investing in an ETF. For instance, the iShares MSCI Emerging Markets ETF offered by Blackrock holds an MSCI ESG rating of A. The rating of A means that the fund practices a strong ESG investment strategy and is a leader in the space. Thus, the large and mid-cap companies included in the ETF represent the fund's core principles, making it a featured iShares ESG listing.
The MSCI rating is only one of several such products. Below are a few notable firms that also provide industry ratings:
- Bloomberg: In 2020, Bloomberg launched a collection of proprietary ESG scores. The initial offering focussed on 252 companies in the fossil fuels sector and a total of 4,300 across various industries.
- Morningstar: Leading investment research company Morningstar offers investors the Morningstar Sustainability Rating. This ratings system is designed to support investors in evaluating relative ESG risks within portfolios.
By referencing scores and ratings, brokerage firms and ETF issuers such as Blackrock and Vanguard are able to custom fit offerings for their clienteles. For investors, this makes the process of choosing a product that reflects their personal values straightforward.
What Are Your Investment Objectives?
Upon reviewing an ESG ETF's prospectus and industry ratings, it's vital to identify one's investment objectives. Even though finding a socially responsible fund may be routine, it's important to select one that meets specific financial criteria.
In the capital markets, there are a variety of ESG ETFs that each excel in certain areas. From fixed income investing and dividends to growth-oriented upstarts, there are a plethora of options. Answering the following questions can help narrow the field:
- What is my investment horizon?
- How much money do I plan to invest?
- What is my risk tolerance?
- Am I seeking extraordinary returns or safety?
These questions will define which type of sustainable investing alternatives are most suitable.
Leading ESG ETFs
Sustainable mutual funds and ETFs are a significant investment sector. For 2021, ESG funds generated a net inflow of US$69.2 billion, a 35% year-over-year increase. Given the size and upward growth trajectory of sustainable investing, there is no shortage of ESG ETF offerings.
Elite sustainable investing funds achieve solid performance while earning high marks for responsible investing practices. Below are two examples of leading funds in this sector.
iShares MSCI USA ESG Select (SUSA)
SUSA is a well-respected ESG fund that holds itself exceedingly accountable to the standards put forth by sustainable investing. It ranks in the 98th percentile among its peers, with over 70% of holdings rated AA or better. Here are a few of this ETF's key stats:
- Top investments are in Apple (AAPL), Microsoft (MSFT) and Google (GOOG). The fund features a 1.37% allocation in safety manufacturer 3M Co. (MMM).
- SUSA screens out many controversial sectors including thermal coal power and weapons manufacturers.
- The fund focuses on climate change and has a low carbon intensity of 45.4 tons per million while realising 7.2% of aggregate revenue from green energy.
- As of February 2022, SUSA posted 12-month gains of 9% and held a MSCI rating of AAA.
SUSA's high MSCI rating and robust performance measures make it an ideal candidate for many ESG investors.
Nuveen ESG Large-Cap Value ETF (NULV)
NULV strives to generate robust returns for stakeholders by promoting the values of sustainable investing. One area where this fund is unique is through its screening process. Companies with exposure to alcohol, weapons, gambling and nuclear power are omitted. Here are a few more of NULV's key metrics:
- NULV has a low carbon intensity of 69.2 tons per million sales.
- The fund's top holdings are JPMorgan Chase (JPM), Procter & Gamble (PG) and Home Depot (HD).
- NULV ranks in the 94th percentile among its peers, with 52% of holdings being rated AA or better.
- As of February 2022, NULV has generated 12 month returns of 8.5% and held an MSCI rating of AAA.
Like SUSA, NULV combines positive returns with a commitment to ESG values. These attributes make it a solid choice for investors interested in sustainability.
An ESG ETF is an exchange-traded fund committed to the principles of sustainable investing. Accordingly, such holdings restrict investments in controversial companies while seeking positive returns. A prominent example in this sector is the FTSE ESG Index Series, which gives investors access to a broad benchmark of ESG performance.
When selecting an ESG ETF, one is well-advised to study the official prospectus and reference the fund's ratings. Market research outlets such as MSCI, Bloomberg and Morningstar offer information on each of these offerings. Ultimately, it's up to the individual investor to decide whether or not ESG ETFs are suitable investment vehicles.
As with all securities, valuations are subject to market conditions and pricing volatility. Past performance is not indicative of future results and discretion is advised when investing.
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