As the universe of environmental, social, and governance (ESG) exchange traded funds continues expanding, advisors and asset allocators are applying more scrutiny to ESG index construction and methodology.
Fortunately, some established ETFs are already meeting new demands. That group includes the SPDR S&P ESG ETF (EFIV). EFIV follows the S&P 500 ESG Index, which is the ESG offshoot of the widely followed S&P 500. That index’s methodology helps allay some of the concerns associated with ESG benchmark construction.
“ESG benefits and active risk are two important factors to be considered within any ESG index strategy. There is generally a trade-off between the ESG benefits achieved by the index and its active risk relative to the benchmark; hence, the two aspects should be looked at collectively,” notes S&P Dow Jones Indices.
EFIV is designed to deliver comparable industry exposures to the S&P 500, though the ESG fund holds 308 stocks compared to over 500 in the parent index. Members of the S&P 500 ESG Index must meet specific ESG requirements to be included in that index.
“If the objective is to achieve high ESG score improvement per unit of tracking error, the S&P 500 ESG Tilted Indices (with various tilting levels) were efficient in meeting this goal,” adds S&P Dow Jones Indices. “The flagship S&P 500 ESG Index stood firmly as the sustainable, benchmark-like option, with relatively low tracking error.”
Low tracking error is important to investors because it minimizes total cost of ownership — a relevant though overlooked component of the ETF ownership experience. As for performance, which is one of investors’ primary concerns when it comes to ditching traditional funds in favor ESG strategies, the S&P 500 ESG Index performed admirably over the past five years relative to the other ESG benchmarks offered by the index provider.
“Simpler exclusions-based indices, such as the S&P Sustainability Screened and S&P Fossil Fuel Free Indices, remove companies involved in specific business activities. Going one step further, some strategies combine exclusions with a single ESG or climate objective, such as increasing exposure to best ESG performers (S&P ESG and S&P ESG Tilted Indices) or to low-carbon emitters (S&P Carbon Efficient Indices),” concludes S&P Dow Jones.
For its part, EFIV doesn’t exclude any of the 11 GICS sectors. However, the fund is overweight on tech stocks relative to the standard S&P 500.
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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.