ESG ETF investors: always take a closer look at the ‘recipe’

Mount­ing atten­tion on sus­tain­abil­i­ty and cli­mate issues has prompt­ed a surge of inter­est in ESG-relat­ed exchange-trad­ed funds (ETFs), with net new asset growth hit­ting 140% last year, com­pared with just 8% for non-ESG ETFs, accord­ing to Qon­ti­go, provider of well-known Euro­pean indices includ­ing the STOXX Europe 600, EURO STOXX 50 and Germany’s DAX. Yet with the vast array of ESG ETFs avail­able on the mar­ket, find­ing the one that is best suit­ed for a par­tic­u­lar investor can often be a chal­lenge.

“Sus­tain­abil­i­ty means dif­fer­ent things to dif­fer­ent peo­ple and ESG ETFs don’t all tar­get sim­i­lar sus­tain­able con­cepts or invest­ment objec­tives,” says Anna Georgie­va, senior sus­tain­able invest­ment spe­cial­ist at Qon­ti­go. “A quick glance at fund names or the indices out there can often be con­fus­ing, even for the most expe­ri­enced investor.”

For Georgie­va, the invest­ment theme and the index methodology—essentially the rules or “recipe” for how to cre­ate the index—are areas where investors should take a clos­er look when select­ing an ETF. For exam­ple, one pop­u­lar theme might be cli­mate, though not all cli­mate-relat­ed ETFs are cre­at­ed the same. One approach could be to exclude cer­tain sec­tors, such as fos­sil fuel-relat­ed com­pa­nies, to reduce car­bon foot­print. Anoth­er approach could be to over­weight com­pa­nies that are per­form­ing bet­ter on cer­tain cli­mate indi­ca­tors, and under­weight those that are under­per­form­ing.

The method­olo­gies behind these ETFs can have impor­tant impli­ca­tions for investors as it shapes the ETF’s expo­sure and thus its behav­iour, includ­ing risk and return, says Saumya Mehro­tra, senior sus­tain­able invest­ment spe­cial­ist at Qon­ti­go.

Giv­en the range of prod­ucts avail­able, investors must start by decid­ing on their own sus­tain­able invest­ment objec­tives and then select­ing a port­fo­lio that is built in align­ment, Mehro­tra says. For exam­ple, are they look­ing to align their invest­ments with their per­son­al val­ues, such as not prof­it­ing from indus­tries and prac­tices they dis­agree with? Or are they look­ing for bet­ter risk-adjust­ed returns through expo­sures to com­pa­nies that are adapt­ing their busi­ness prac­tices to keep up with the sus­tain­able tran­si­tion? Or per­haps they want to use their cap­i­tal to make the world a bet­ter place through a more spe­cif­ic impact invest­ment?

For now, ETFs that adopt a broad approach using an over­all ESG mea­sure make up the bulk of the mar­ket, yet the fastest grow­ing approach­es are more impact-ori­ent­ed or the­mat­ic, such as a focus on the Unit­ed Nations Sus­tain­able Devel­op­ment Goals or stand­alone social or envi­ron­men­tal themes, says Georgie­va. The mar­ket has also start­ed to move away from pure exclu­sion-based approach­es towards more opti­mised strate­gies that can bet­ter achieve sus­tain­abil­i­ty goals with­out devi­at­ing too much from the broad mar­ket.

An addi­tion­al point to bear in mind is the inher­ent diver­gence in the cal­cu­la­tion of ESG met­rics from dif­fer­ent data providers that are used for index design. These dif­fer­ences in cal­cu­la­tions can lead to entire­ly dif­fer­ent out­comes, even if those ETFs have the same goals, says Georgie­va. Con­tin­u­ing with our cli­mate exam­ple, to mea­sure cli­mate risk or expo­sure, you need a proxy. One ESG met­ric under­pin­ning a fund might use a company’s com­mit­ment to sci­ence-based cli­mate tar­gets (SBTs) for emis­sions reduc­tion as its proxy, while anoth­er might mea­sure the qual­i­ty of the company’s report­ing accord­ing to the Task Force on Cli­mate-relat­ed Finan­cial Dis­clo­sures (TCFD), a frame­work intend­ed to uni­fy cor­po­rate dis­clo­sures on cli­mate-relat­ed finan­cial risk.

“Fun­da­men­tal­ly, both are try­ing to mea­sure the same things, but come out with dif­fer­ent expo­sures because of dif­fer­ent prox­ies,” says Mehro­tra.

Giv­en the diver­si­ty of ETFs, it’s no sur­prise investors face chal­lenges when try­ing to invest sus­tain­ably. There is a strong need for trans­paren­cy, greater flex­i­bil­i­ty in approach and more pre­ci­sion in access­ing spe­cif­ic invest­ment objec­tives.

“Qual­i­ty data is more impor­tant than quan­ti­ty at this stage and mean­ing­ful prod­uct design is para­mount,” says Georgie­va.

Qon­ti­go is heed­ing the call to pro­vide sus­tain­abil­i­ty-mind­ed investors with those explain­able invest­ment solu­tions. By col­lab­o­rat­ing with ETF issuers, lead­ing data providers, stake­hold­ers from acad­e­mia and the glob­al not-for-prof­it sec­tor, Qon­ti­go aims to be a cat­a­lyst for the shift to the next gen­er­a­tion of trans­par­ent, effec­tive and high­ly-tar­get­ed ESG ETFs.

For more infor­ma­tion please vis­it qontigo.com

Pro­mot­ed by Qon­ti­go