ESG Improvers Can Boost Returns | ETF Trends

As advisors and investors gain more familiarity with environmental, social, and governance (ESG) investing, they likely come across data points and research confirming that equities with strong ESG traits can deliver solid returns.

Taking that principle a step further, evidence suggests that ESG “improvers,” or those companies that are making ESG strides, can generate similar positivity for investors. That could enhance the appeal of broad-based exchange traded funds, such as the SPDR S&P 500 ESG ETF (EFIV).

EFIV, which follows the S&P 500 ESG Index, is home to 304 stocks, confirming it has the breadth necessary to capitalize on a variety of ESG trends. Another point in favor of the ETF is that with a lineup that large, it’s likely some member firms can improve their standing.

“But while traditional ESG screens focus on companies that are already scoring well on sustainability factors, a complementary approach may be to look at whether companies are steadily improving on ESG metrics. Companies that are making significant improvements — in sustainability metrics as well as traditional financial metrics – have the potential to outperform on both fronts,” according to Morgan Stanley research.

Another point worth noting about EFIV is that with its underlying index’s ties to the standard S&P 500, the ETF is an accurate ESG reflection of the parent benchmark. Over the long-term, that’s a potentially useful trait because, as experienced investors know, some sectors are home to more ESG-improver candidates than others. Those include energy and utilities.

“Utilities offer one case in point. In the U.S. utilities sector, many companies are shutting down expensive coal-fired power plants and building renewables, energy storage, and transmission,” adds Morgan Stanley. “Right now, they would screen negatively on classic ESG metrics, such as carbon intensity. However, these ‘ESG improvers’ may be positioned to deliver superior stock returns and play a critical role in the transition to clean energy by reducing consumer energy costs, cutting carbon emissions, and improving utility earnings-per-share growth.”

As the investment bank notes, there could be an attractive long-term opportunity in “rate of change” ESG companies, or those firms that are improving on fronts such as ESG-tied sales, realizing ESG related cost efficiencies and tapping into “favorable cost of capital, typically due to reduced risk based on improving ESG metrics.” Some such firms may already reside in EFIV while others might join the ETF’s portfolio over time.

For more news, information, and analysis, visit the ESG Channel.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.