The Benefits of Adding ESG ETFs into a Diversified Portfolio | ETF Trends

Exchange traded fund investors should consider the potential benefits of environmental, social, and governance, or ESG, investing and how they can utilize ESG strategies to enhance possibly, or even replace, core portfolio positions.

In the recent webcast, Income Investing – Adding ESG to the Equation, Margaret Dorn, Senior Director, ESG Product Strategy, S&P Dow Jones Indices, explained that ESG factors are not entirely dissociated with how companies conduct their businesses. For example, she underscored the links between ESG and corporate performance, such as environmental considerations, productivity, regulations, societal trends, overall ESG strategies, and revenue opportunities.

As a way to better help investors target companies with a greater focus on ESG attributes, S&P Dow Jones Indices has come out with the S&P 500 ESG Index, which acts as the underlying benchmark for the more recently launched Xtrackers S&P 500 ESG ETF (SNPE). The underlying index seeks to target 75% of the float market capitalization of each Global Industry Classification Standard Industry Group within the S&P 500 Index, using an ESG score as the defining characteristic. It screens to exclude tobacco, controversial weapons, low UNGC scores, and the bottom 25% of S&P DJI ESG scoring companies within each global GICS Industry Group.

The S&P 500 ESG Index enhances ESG representation, as compared to the more widely observed U.S. benchmark. For example, the ESG index provides +8% exposure to companies that analyze their sources of Scope 3 emissions, +10% third-party verified emission data, +9% exposure to companies with GHG emission reduction targets, +9% exposure to companies actively monitoring diversity-related issues, +7% female representation in all management positions, +7% more exposure to companies assessing human rights issues across their business, +8% exposure to companies that perform and disclose ESG materiality analysis, +7% exposure to companies with a diversity policy regarding board nominations, and +9% exposure to companies with a public Supplier Code of Conduct that covers working conditions.

The ESG indexing methodology could also provide improved risk-adjusted returns for long-term investors. The S&P 500 ESG Index saw a 10.77% 1-year return with a 21.43% standard deviation while the S&P 500 Index saw a 7.51% return with a 21.88% standard deviation. Additionally, looking at the 10-year annualized returns, the S&P 500 ESG Index generated a 14.28% return with a 13.13% standard deviation, compared to the S&P 500’s 13.99% return with a 13.42% standard deviation.

Sean Edkins, Head of ETF Sales and Strategic Partnerships, DWS, pointed out an investment that considers sustainability isn’t about changing the world but rather about understanding how the world is changing. ESG investments try to address issues such as water scarcity, tax transparency, rising sea levels, infectious diseases, privacy & data security, regime stability, air pollution, aging population, and more.

Edkins argued that wealth and demographic shifts might also contribute to the growing interest in ESG investments, notably the rising income and wealth among the millennial and women groups. Millennials could have net worth up to the $20 trillion range, and 95% of millennials have shown intentions to allocate to responsible investments. Additionally, $22 trillion is expected to pass from baby boomers to millennials over the next 25 years. Meanwhile, female investors are twice as likely as their male counterparts to consider sustainability alongside return when investing.

Bob Smith, President & Chief Investment Officer, Sage Advisory, also underscored the benefits of including ESG-related bonds or so-called green bonds into a diversified fixed-income portfolio. Impact or green bonds and investment-grade corporate bonds can be incorporated into a core fixed-income portfolio solution, along with satellite holdings in ESG-related international and high-yield bonds.

As a way to help investors better diversify with ESG investments, DWS has come out with a suite of both fixed-income and equity ESG ETF strategies. On the fixed-income side, DWS offers the Xtrackers MSCI USA ESG Leaders Equity ETF (NYSE Arca: USSG), Xtrackers Bloomberg Barclays US Investment Grade Corporate ESG ETF (Cboe: ESCR), Xtrackers J.P. Morgan ESG USD High Yield Corporate Bond ETF (Cboe: ESHY) and Xtrackers Bloomberg Barclays US Investment Grade Corporate ESG ETF (Cboe: ESCR).

Along with the previously mentioned SNPE, DWS also offers Xtrackers MSCI EAFE ESG Leaders Equity ETF (NYSEArca: EASG), Xtrackers MSCI Emerging Markets ESG Leaders Equity ETF (NYSEArca: EMSG), and Xtrackers MSCI ACWI ex USA ESG Leaders Equity ETF (NYSEArca: ACSG) to target both domestic and foreign companies.

Financial advisors who are interested in learning more about ESG strategies can watch the webcast here on demand.