[This article originally appeared in our March issue of ETF Report.]
One of 2016's big themes was the mass of filings and launches for exchange-traded funds focusing on environmental, social and governance factors, commonly known as ESG, nearly doubling the space.
By ETF.com’s count, there are nearly 50 funds that focus on sustainable investing, a catch-all term that covers ESG factors, socially responsible investing and other values-based investing. In 2016 alone, there were 21 sustainable funds launched, with the majority of those coming in the second half of the year.
Those new funds count up to roughly $725 million in assets out of a total of $3.5 billion for the space. Not surprisingly, the largest broadly focused sustainable ETF by assets under management is also one of the oldest, the iShares MSCI KLD 400 Social ETF (DSI), a total-market ETF. It has $768 million in AUM, an expense ratio of 0.50% and debuted in 2006.
However, one of last year’s socially responsible ETFs has already cracked the top-five list in AUM, the SPDR SSGA Gender Diversity Index ETF (SHE), a U.S. large-cap fund. It debuted in March 2016, and has $283 million in AUM and an expense ratio of 0.20%. It should be noted, though, that pension fund CalSTRS seeded the fund with $250 million at its launch.
Theme Trickled Down To Retail
A few factors are driving the growth in the ETF trend, several sources say. This type of investing first gained traction with large institutions such as pension funds and high net worth individuals, and as with many investment trends, trickled down to financial advisors and retail buyers.
Because of its focus on criteria such as impact on the environment, and improving social welfare and corporate governance, these issues appeal to younger investors and female investors, the sources say. What’s helped product development is a greater amount of data available from companies and other researchers that moved sustainable investing out of the realm of screening-out companies based on values to one that can be integrated into core asset allocation.
“Particularly on the ETF side and passive investing in general, certainly the development and maturation of the company-level ESG research has helped a lot. It gives you many options for how to build interesting passive portfolios,” said Jon Hale, head of sustainability research at Morningstar. Last year Morningstar unveiled a new system allowing financial advisors to look at how any fund—conventional or socially responsible—rates on sustainability.
Asset Allocation Integration
Tom Kuh, executive director of ESG Indexes at MSCI, concurs. He says that in the fourth quarter of 2016 alone, there were nine ETF launches based on MSCI products, all of them MSCI ESG indexes or developed in conjunction with the ETF issuers. Kuh says MSCI has noticed that the new products being developed are integrating these factors into asset allocation rather than thinking about ESG as a separate entity.
“We’ve seen several and expect to see more fund providers giving investors the opportunity to bring ESG strategies to core assets,” he noted.
Hale said early sustainable investing ETFs focused on themes like water and energy, but now many of the funds have broadly diversified themes.
Growing Excitement, But Not Assets … Yet
Although socially responsible investing has been around for some time—and given the number of new product launches, there’s excitement around the theme—total assets invested suggests it remains in the niche category.
Katie Schoen, senior equity analyst, private wealth, management equity strategy at Robert W. Baird, said while the case for ESG investing is easy to make, assets haven’t followed. She notes that at $838 million, the PureFunds ISE Cyber Security ETF (HACK) has more assets than DSI. That trend, she says, is similar at Baird in terms of the firm’s assets invested in the two funds. She added it’s possible asset growth is slow because it’s been difficult to build broad-themed ESG investments for retail investors who often might have a different definition of sustainability.
“What retail investors consider ESG changes with each one you talk to,” she said.
Socially responsible investing isn’t going away, but it may take some time for financial advisors and their clients to catch on, Schoen notes.
Recent Fiduciary Development
It’s only been since late 2015 that the Department of Labor granted permission for fiduciaries to use ESG factors when making investment decisions. MSCI’s Kuh said not only did the DoL grant permission, but if the ESG factors are material, there’s a fiduciary duty to take account of them.
Joey Fishman, investment advisor representative and unofficial director of ESG at Ritholtz Wealth Management, says the firm just started using these types of ETFs in January after researching them for a year. He said having much more data available and seeing how analysts arrived at their conclusions was instrumental to its process.
Its models are weighted heavier on the environmental and governance factors and less on the social, he says, because it believes there’s stronger data supporting the E and the G, and less the S. There’s less of a business case for social, he notes.
“It’s a moralistic assumption of what you feel should be included, and we’re trying to move away from that. Our whole schtick is we’re evidence-based investors. As long as we follow the evidence and stay on the right side of the data, we’ll be in a good place and our clients will be in a good place,” Fishman said.
Another reason to debut the model now is that costs are in line. “We’re priced 30 basis points for the portfolio. Five years ago, it would be three-quarters or seven-eighths of a percent,” he said.
Early client interest is strong, Fishman notes. Although he didn’t say which ETFs are in their model, Fishman said Ritholtz looks for pragmatic ETFs such as ones offered by iShares.
Komson Silapachai, senior investment analyst at Sage Advisory, said it launched its ESG strategies last year, and that being able to use the Morningstar sustainability ratings allowed his firm to build core portfolios to express which characteristics it wants. Interest around climate change has been big.
Greater demand from clients and being able to use more research tools was part of the motivation to move into the space. While there’s some client demand for ESG, Silapachai said there’s still a learning curve for many.
“With our presentations, we start with how we define it, where we stand, how we manage money,” he added.