ETFs that incorporate environmental, social and governance principles are more than a gimmick as they provide investors with a diversified core portfolio position that is capable of avoiding some risk-off events due to the underlying companies’ more socially responsible culture.
Societe Generale recently quantified the potential consequences of companies that don’t follow ESG principles, revealing that in two thirds of “high ESG controversy” cases, a company’s stock experienced “sustained underperformance” or trailed the global index by an average of 12 percentage points over the following 2 years, CNBC reports.
A high ESG controversy is defined as “when a company’s activity has unintended and/or undesired negative environmental and/or social effects on stakeholders, with corresponding reputational risk,” Societe General said, adding that it’s the “extreme ESG downside risk, with at times a massively negative impact on company share prices.”
Basically, companies that followed ESG principles are more likely to avoid negative events that could weigh on their bottom line. So, it might be better for a company, along with an investor’s portfolio, if more followed ESG guidelines.
“A controversy event will halt the rise in a stock price, and for a sustained period: a solid two years … Prior to the high controversy occurring, these companies were typically performing in line with the market,” Societe Generale analysts led by Charles de Boissezon said.
ETF investors who are interested in gaining exposure to these companies that follow ESG principles can look to ETF specific strategies. For example, the iShares MSCI USA ESG Optimized ETF (NasdaqGM: ESGU) has attracted billions of dollars and is now the largest ESG-specific ETF on the market. The fund tracks U.S. stocks taken from the MSCI USA Index that have positive environmental, social and governance characteristics
DWS has also partnered with MSCI Inc. to launch a number of ESG-themed ETF strategies to help investors find a more readily accessible means to tap into this investment methodology. For example, the Xtrackers MSCI USA ESG Leaders Equity ETF (NYSE Arca: USSG) has been a popular play for investors seeking exposure to socially responsible investments. USSG was developed in collaboration with Ilmarinen, Finland’s largest pension insurance company. The underlying MSCI USA ESG Leaders Index provides exposure to large- and medium-cap U.S. companies with high environmental, social and governance (ESG) performance relative to their sector peers.
Additionally, Vanguard’s first ESG-themed ETF, the Vanguard ESG U.S. Stock ETF (NYSEArca: ESGV) , exclude companies producing adult entertainment, alcohol and tobacco products, conventional and controversial weapons (including civilian firearms), fossil fuels, gambling activities, and nuclear power. The underlying index also excludes companies that do not meet certain diversity criteria, as well as the labor, human rights, anti-corruption, and environmental standards defined by the Ten Principles of the United Nations Global Compact.
For more information on socially responsible investments, visit our socially responsible ETFs category.