Exchange traded fund investors who are considering the environmental, social and governance theme should take a step back to consider ESG investments from the macro perspective, looking beyond the immediate implications of politics and to the broad economic and social trends driving greater ESG adoption.
In the recent webcast, ESG 2021: What’s Next For This Dominant Trend?, Mona Naqvi, Senior Director, Head of ESG Product Strategy, S&P Dow Jones Indices, highlighted their S&P 500 ESG Indexing methodology. The customized ESG benchmark excludes sectors involved in tobacco, controversial weapons, thermal coal, low UNGC scores, and the bottom 25% of S&P DJI ESG scoring companies within each global GICS Industry Group. The Index would then sort eligible companies by S&P DJI ESG Score within each GICS Industry Group, and select top performing companies, targeting 75% within each GICS Industry Group.
Specifically, Naqvi underscored the S&P 500 ESG Index impacts through its screening methodology. For example, on the environmental side, the methodology provides exposure to companies that analyze their sources of Scope 3 emissions, third-party verified emission data and exposure to companies with GHG emission reduction targets. The social aspect covers exposure to companies actively monitoring diversity-related issues; female representation in all management positions including junior, middle, and senior management; and more exposure to companies assessing human rights issues across their business. Lastly, the governance principle measures exposure to companies that perform and disclose ESG materiality analysis, exposure to companies with a diversity policy regarding board nominations, and exposure to companies with a public Supplier Code of Conduct that covers working conditions.
The result is an ESG Index with sustainable performance with benchmark-like returns similar to the widely observed S&P 500. Specifically, the S&P 500 ESG Index exhibited a 14.05% 10-year annualized return with a 13.07% 10-year standard deviation, compared to the benchmark S&P 500’s 13.74% 10-year annualized return with a 13.25% 10-year standard deviation.
The ESG Index is also outperforming this year, showing a 18.09% 1-year return, compared to the S&P 500’s 15.15% 1-year return. Naqvi attributed the S&P 500 ESG Index’s outperformance to its greater tilt toward the momentum and quality factors this year.
ETF investors can gain exposure to this strategy through the recently launched SPDR S&P 500 ESG ETF (EFIV). The ETF tracks the S&P 500 ESG Index, which helps measure the performance of securities meeting certain sustainability criteria (i.e. criteria related to environmental, social, and governance factors) while maintaining a similar overall industry group weight as the S&P 500 Index.
Bob Smith, President & Chief Investment Officer, Sage Advisory, also pointed out that a majority of currently listed ESG-related ETFs follow a type of negative screening or screening restrictions that include controversial weapons, nuclear energy, tobacco, coal, small arms and fossil fuels. Nevertheless, it is important for investors to do their due diligence and consider the ESG investment framework or underlying ESG data profile.
“Fund scores provide a measure of how well the holdings in a portfolio are managing their environmental, social, and governance (ESG) risks and opportunities,” Smith said.
“As ETF investors, it’s important to align with ETF sponsors that are actively engaged on shareholder issues,” he added.
The ESG theme has grown in popularity this year. Michael Arone, Chief Investment Strategist, SPDR, State Street Global Advisors, pointed to three major driving trends that has helped fuel this growth, including the Great Reset in a turbulent 2020, more informed investors reshaping the investment industry, and the transfer of wealth from Baby Boomers to the younger generation. Looking ahead, Arone projected ESG ETFs and Index mutual funds to attract $1.3 trillion in assets under management by 2030, compared to the current $170 billion in assets now.
Financial advisors who are interested in learning more about ESG investing can watch the webcast here on demand.