Environmental, social and governance, or “ESG,” investing is a broad term covering a range of themes, from low-carbon emissions to gender diversity. Essentially, it’s investing with a conscience.

Long dismissed as the singular fancy of granola-crunching hippies, ESG has recently amassed mainstream appeal. As of 2014 (the latest date for which data was available), assets in ESG investments had totaled $6.57 trillion, a 76% increase since 2012, according to USSIF, the Forum for Sustainable and Responsible Investment. 

When it comes to ESG ETFs, however, there’s still plenty of room to grow.

Only 23 ETFs qualify as “socially responsible” (or “principles based”), according to ETF.com. (This doesn’t include environmentally friendly ETFs, which often fall under different classifications.) Eleven—or almost half—only came to market in 2016.

Together, these 23 funds make up just $1.93 billion in assets—a miniscule amount, compared with the $2 trillion invested in comparable mutual funds.

“It’s a small speck in a giant ocean,” said Greg Lessard, founder of Aspen Leaf Partners, a Golden, Colorado-based advisory firm that invests solely in ESG products. “ESG is still a niche market, but the potential is there to grow, and grow quickly.” 

Tipping Point

We believe 2017 will be a tipping point for ESG ETFs, for two reasons.

The first: enthusiasm. A recent survey by U.S. Trust found that interest in so-called impact investing (yet another term for ESG) was on the rise among high net worth women, millennials, Gen Xers and investors with at least $10 million in assets. All demographics roughly doubled their ownership of ESG investments in 2016—with the exception of the $10 million+ investors, who tripled it.

Growth will also likely be driven by pension funds, banks and other large institutional investors, who’ve gravitated in recent years toward companies that are more environmentally friendly and that have better governance. 

The second reason we think ESG ETFs will hit critical mass in 2017? Performance. When you crunch the numbers, ESG actually seems to work better than vanilla indexing.

For example, over a three-year period, the MSCI EAFE ESG Index outperformed the MSCI EAFE Index by more than 120 basis points, according to analysis by FactSet.

As issuers realize this potential boost, we’ll likely see more products launched—even smart-beta twists, such as the offerings by Oppenheimer Funds, who filed for two revenue-weighted ESG ETFs in August. 

ESG ETFs do face a big head wind, however: fees. Though newer funds are cheaper, the average expense ratio in the space is 0.49%. The AdvisorShares Global Echo ETF (GIVE) charges a whopping 1.50%. It remains to be seen whether competitive pressure will push expenses down.

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