Exchange traded funds that track the environmental, social, and governance theme could also hold crude oil companies and so-called sin stocks like gambling hotels and cigarette producers. It is up to the investor to take the time and look under the hood of their investments to better know what they are getting themselves into.
While most ESG funds avoid the more egregious ESG-rated companies, many ESG-related funds are still based on widely observed global benchmarks, so they can’t completely avoid oil companies or sin stocks that may be highly rated on one ESG factor like governance, but poorly rated on one or both of the others.
Another key factor may be attributed to institutional investors that pay attention to the “tracking error” or difference between custom indexes and the broader market, MarketWatch reports.
“It ultimately comes down to they (asset managers) don’t want to have big tracking error, because the bigger the tracking error rate, the less likely institutional investors are going to be to put money into the portfolio,” Peter Krull, CEO of Earth Equity Advisors, a financial planners focused on sustainable, socially responsible, and impact investment management, told MarketWatch.
Consequently, some of the biggest ESG ETFs take a broad, sector-neutral stance on the ESG theme, and the fund providers clearly state what they are doing in their prospectus sheets.
However, some may be confusing sustainable investing with ESG-based investing. Krull argued that sustainable investing is more than these ESG metrics, since the philosophy is based on using personal values to invest in companies that a person believes will provide a positive impact on our society while outperforming in the long run.
Vikram Gandhi, senior lecturer in the entrepreneurial management unit at Harvard Business School, argued that ESG indexes that exclude large market segments like the oil sector may not be an easy sell for large institutions like pensions funds that have a fiduciary obligation and cannot deviate too far from a traditional benchmark.
“If the investor is a big family office and says I do not want to invest in natural resources, the asset manager will be very happy to create an ETF that has no energy companies in it,” Gandhi told MarketWatch. “But I would argue that most large fiduciary holders of assets would not be able to invest in that ETF.”
For more news, information, and strategy, visit the ESG Channel.