Where Are The ESG Flows?

February 21, 2018

[This article appears in our March issue of ETF Report.]

Despite the superstar-level hype around ESG ETFs the past few years, JUST A handful have become bona fide hits.

Of the 65 ETFs classified as “socially responsible,” only one has broken $1 billion in assets under management: the iShares MSCI KLD 400 Social ETF (DSI). Fourteen others have topped $100 million in assets, a common liquidity threshold that many investors use to gauge a fund’s seaworthiness (see Figure 1).


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That’s just 15 ETFs in 13 years, together totaling less than $5 billion in assets. Forget Beyoncé—most ESG ETFs are still struggling to be even as popular as Bon Iver.

The question is, why?

Mutual Funds Hold On Tight
Ironically, ESG’s failure to launch in the ETF world stems from its massive popularity among mutual funds, says Todd Rosenbluth, director of ETF and mutual fund research for CFRA.

“ESG mutual fund assets have been quite sticky, even as most actively managed mutual funds slowly bleed assets in favor of passive, index-based ETFs,” he noted.

A recent report from McKinsey & Co. found that $22.89 trillion—one-quarter of all assets managed worldwide—was invested according to environmental, social and governance principles. At $4.8 billion in assets under management, U.S. ESG ETFs represent a mere 0.02% slice of that pie.

ESG investors, driven by the conviction of their values, are willing to ride out periods of underperformance, even those driven by higher active management costs, adds Rosenbluth. “We see ESG investors being more patient with their existing products, as long as they can continue to be in the markets in a way they feel good about.”

Field-Of-Dreams Theory
However, Sarah Lee Kjellberg, director and head of U.S. iShares sustainable ETFs, offers a different theory: “People have been asking for years, ‘Where are the [ETF] assets?’ 
My question is, ‘Where are the products?’”

For more than a decade after the first set of ESG ETFs launched in the U.S., the number of these products remained miniscule, says Kjellberg. The years 2010, 2011 and 2013 saw zero new ESG ETFs launched.

Then 2016 “changed the landscape,” said Kjellberg. That year, 22 ESG ETFs launched, followed by another 18 in 2017. In January, two additional ESG ETFs launched, the InsightShares LGBT Employment Equality ETF (PRID) and the InsightShares Patriotic Employers ETF (HONR), with several more funds already in registration.

Call it the “Field of Dreams” theory: If issuers launch ESG ETFs, investors will come. And that theory seems to be borne out in the flows into ESG ETFs. As the number of ETFs drastically rose between 2015 and 2016, new net inflows into the space more than tripled. In 2017, net inflows topped $1.6 billion, a 39% year-over-year rise (see Figure 2).



That said, newer ETFs aren’t, by and large, the ones gaining the lion’s share of assets. In fact, most of today’s biggest ESG ETFs took years to cross the $100 million mark, despite notable exceptions like the SPDR SSGA Gender Diversity Index ETF (SHE), which had millions in seed capital from CalSTRS right out the gate. Only one of today’s largest 15 ESG ETFs launched in 2017; almost half (48%) are at least five years old.

That suggests that many investors were either unaware of the ETFs’ presence or wary of newer products without long track records to back them up, said Kjellberg at the 2018 Inside ETFs “Everything You Need To Know: ESG Strategies” panel.

Broad ESG ETFs Find Appeal
Among the handful of ESG ETFs that have found success, there are a few common themes.

For starters, despite the attention given to thematic ESG ETFs, like the Point Bridge GOP Stock Tracker ETF (MAGA), broad-based ESG ETFs are the clear winners in terms of assets.

In fact, several of the most popular ESG ETFs explicitly aim to match the performance of existing broad market indexes, like the MSCI ACWI Index or the MSCI USA Index. These include the iShares MSCI USA ESG Select ETF (SUSA);* the iShares MSCI ACWI Low Carbon Target ETF (CRBN) and the SPDR MSCI ACWI Low Carbon Target ETF (LOWC), which share the same index; and the Nationwide Maximum Diversification U.S. Core Equity ETF (MXDU).

This suggests that, rather than ESG functioning as a thematic supplement with which investors can express single-issue views, investors instead use ESG as a replacement for existing broad allocations.

That lines up well with ESG’s appeal to institutions, which increasingly turn to ESG as a way to carry out their fiduciary responsibility to investors.

“ESG is just good investing. You can end the sentence there,” said Aniket Shah, head of sustainable investing for OppenheimerFunds. “And if you do think that ESG is just good investing, then you’ll want to apply it to as broad a pool of your investments as possible.”

Low Carbon
Of the thematic ETFs that have succeeded, however, one theme is dominant: climate change risk.

Seven of the largest 15 ETFs focus on mitigating climate-change risk in some way, whether by eliminating exposure to fossil fuel companies, as in the SPDR S&P 500 Fossil Fuel Reserves Free ETF (SPYX); or by capitalizing on the global rush toward renewable energy sources, as in the Guggenheim Solar ETF (TAN).

Still other ETFs, like LOWC and CRBN, look to specifically invest in companies making an active effort to lower their carbon footprint, through sustainable energy sourcing and greater energy efficiency throughout their operations.

As the world suffers more frequent and more costly climate events, low-carbon ETFs may increasingly appeal to investors, notes Shah, particularly institutions looking to mitigate their climate change risk.

“You’re seeing governments and big business leaders now going after these issues,” he said. “So for people who think this is a fad, I’d say you’re probably mistaken.”

Opportunity In The Wild West
As it stands now, the ESG ETF space remains a Wild West. Unlike the broader ETF market, which has effectively been colonized by the Big Three—Vanguard, iShares and State Street—ESG remains a greenfield of opportunity for smaller issuers, where products by Guggenheim, Global X, Nationwide and WisdomTree have all gained significant assets.

“We expect the product landscape to remain diverse,” said Rosenbluth. “And I think that’s healthy, because what appeals to one investor about ESG isn’t going to be the same as what appeals to someone else.”

Yet for all that diversity, there remain significant coverage gaps in ESG, especially in fixed income or alternative asset classes. Only six ESG bond ETFs exist, for example, with barely $125 million in assets between them. The largest, the NuShares ESG U.S. Aggregate Bond ETF (NUBD), has just $42 million in assets.

“I do think the industry will catch up, and catch up quickly,” said Shah. “It’s part of the evolution of capitalism to embed ethical principles in the allocation of capital. ESG is just the next chapter of that.”

*SUSA adopted its current ticker in July 2017. Previously, it used the ticker KLD.


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