I was doing final prep work for the VettaFi Equity Symposium last week (close to 500 live attendees and more will catch the replay). However, the regulators made asset management news with their focus on “truth in advertising.” Despite their well-intentioned efforts, it will remain paramount for investors to do their homework and look inside the portfolio.
Naming Conventions for ETFs
The Securities and Exchange Commission (SEC) adopted amendments to the Investment Company Act “Names Rule.” This addressed fund names that they said were “likely to mislead investors about a fund’s investments and risks.”
According to the SEC, “typically, a fund’s name is the first piece of information that investors receive about a fund, and fund names offer important signaling for investors in assessing their investment options.”
The SEC believes “the amendments to the Names Rule will enhance the rule’s protections by requiring more funds to adopt an 80 percent investment policy.” This now includes funds with names suggesting a focus on investments with certain characteristics. For example, terms such as “growth” or “value” were highlighted. In addition, certain terms that reference a thematic investment focus, such as the incorporation of one or more environmental, social, or governance factors were called out by the regulators.
The amendments will include enhanced prospectus disclosure requirements for terminology used in fund names. This includes a requirement that any terms used in the fund’s name that suggest an investment focus must be consistent with those terms’ plain English meaning or established industry use.
This Sounds Good… In Theory
I have long advocated going way beyond the fund name (or cool ticker) to ensure you are making adequate let alone sound investment decisions for yourself or your client.
However, growth, value, and environmental, social, and/or governance ETFs are very different from one another even though they provide adequate disclosure in my opinion (in full disclosure I went to business school, not law school).
What’s Inside 2 iShares Growth ETFs
The iShares Russell 1000 ETF (IWF) has $69 billion in assets. Per its prospectus, IWF seeks to track the investment results of the Russell 1000 Growth Index. The underlying index measures the performance of equity securities of Russell 1000 Index issuers with higher price-to-book ratios, higher forecasted medium-term growth, and higher sales-per-share historical growth relative to all issuers whose securities are included in the Russell 1000 Index.
IWF’s top-20 holdings included Apple, Microsoft, and Nvidia but also Chevron and Exxon Mobil.
The iShares S&P 500 Growth ETF (IVW) has $34 billion in assets. Per its prospectus, IVW seeks “to track the investment results of the S&P 500 Growth Index. The growth characteristics used by the index provider include a three-year change in earnings per share over price per share, three-year sales-per-share growth rate, and momentum (12-month percentage share price change).”
IVW’s top-10 holdings included Apple, Microsoft, and Nvidia but also Meta Platforms and Netflix. Chevron and Exxon Mobil are not IVW constituents. Meanwhile, Meta Platforms and Netflix are not a part of IWF. Investors in S&P 500 or Russell 1000 Value ETFs will find the stocks that are missing.
Does this matter? Yes. IWF was up 25.3% year-to-date through September 21, outpacing IVW’s 18.5% gain.
Broad ESG ETF Can Differ Even With the Same Index Provider
Let’s look at two broad strategies that cover the three ESG pillars in one portfolio.
The iShares ESG Screen S&P 500 ETF (XVV) has $180 million in assets. Per the prospectus, XVV seeks to track the investment results of the S&P 500 Sustainability Screened Index. The Index Provider constructs the Underlying Index starting with the S&P 500. Based on its eligibility criteria, the index behind XVV excludes companies. These include those involved in the business of tobacco, controversial weapons, manufacturers and major retailers of small arms, and companies involved in certain fossil-fuel-related activity.
XVV holds 451 of the S&P 500 constituents but does not own Exxon Mobil, Johnson & Johnson, and Walmart.
Meanwhile, the SPDR S&P 500 ESG ETF (EFIV) has $950 million in assets. Per the prospectus, EFIV seeks to track the S&P 500 ESG Index, The index is designed to measure the performance of securities meeting certain sustainability criteria (criteria related to ESG factors). It also excludes companies involved in tobacco and controversial weapons and other factors.
The remaining companies are then ranked based on their S&P Dow Jones Indices ESG Score. For each GICS industry group, companies are selected for inclusion in the index primarily in decreasing order of S&P DJI ESG Score until approximately 75% of the float-adjusted market capitalization of the industry group is reached.
EFIV owns 319 of the S&P 500 constituents but does not own Berkshire Hathaway, Broadcom, or Meta Platforms. It also does not own Exxon Mobil, Johnson & Johnson, but it owns Walmart.
Does this matter? XVV was up 16.5% year-to-date through September 21, outpacing EFIV’s 15.6% gain.
Will Anything Change?
I don’t believe iShares or State Street Global Advisors is doing anything wrong in these examples. They disclose the index criteria and how growth or ESG is incorporated. Could more be added?
Sure, but I’m skeptical about how much help it will provide. Advisors and investors using these ETFs will have different experiences based on what is in the portfolio.
The impact is more likely going to be on currently yet-to-be-launched ETFs that seek to use these terms. Will we see fewer ETFs that include ESG in its name come to market? Yes. But that has as much to do with the insufficient demand. We could see more clarity in the new names.
This already exists. Investors that only want to focus on climate change and not corporate governance should focus on perhaps the Engine No 1 Transform Climate ETF (NETZ). While corporate governance supporters might prefer the WisdomTree Emerging Markets ex-State Owned Enterprises ETF (XSOE).
As a father of a 13-year-old and head of research trying to keep up with the 3,000-plus U.S.-listed ETFs, it gives me no pleasure to say it, but there’s still homework to be done. Let’s get going.
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