The Last Word: Murky Waters

This issue of ETF Report attempts to tease out the different elements that make up the pillars of ESG investing: environmental, social and governance, to be precise.

Because really, the whole concept of ESG investing is nebulous. Everyone has a different definition, usually one centered around what’s important to them.

The debate originally focused on the idea that if investors were going to invest according to the dictates of their conscience, they’d give up some of the market returns, at least in the short term.

But issuers of ESG products, and index provider research, have been challenging that belief lately, some going as far as saying that ESG screens should improve performance. Merrill Lynch, Goldman Sachs, Morgan Stanley and Just Capital are a few of the firms that’ve published research supporting this view.

It’s also just logical. Companies that are not involved in “controversial” business lines—like weapons or tobacco—are less likely to face lawsuits from the public. Likewise, corporations that treat all of their employees well will probably see lower staff turnover and won’t get sued by disgruntled workers. Companies with sound environmental policies are less likely to be subject to government fines or censure.

It’s not all hearts and flowers. ESG investing certainly can make investors feel good about making a positive impact. However, you can also look at it as a risk reduction strategy in that it takes potential problems off the table and sets up the portfolio for possible outperformance over the longer term. Of course, when you take one risk off the table, you also may add some others.

Fine-Tuning
But if you don’t think a broadly focused ESG fund aligns with your primary concerns, you still have some choices. You can also invest in an ETF that supports a particular cause you believe in rather than every cause.

There are currently funds that simply exclude companies with fossil fuel reserves or that target companies supporting women or minorities. There are also ETFs that focus specifically on clean or renewable energy. Using such funds, investors can build a portfolio that reflects their key areas of concern.

There are even ETFs that reflect the beliefs of different religions, including evangelical Christianity, Catholicism and Islam.

But if general ESG concerns are your thing, you don’t even have to select an ETF bearing that label. MSCI is one of the best-known firms offering ESG ratings and analytics, and ETF.com has incorporated that data into its screener tool (https://www.etf.com/etfanalytics/etf-finder/). Nearly 1,500 ETFs in ETF.com’s universe of more than 2,300 funds have ESG ratings from MSCI.

Different Approach
Of those ETFs for which MSCI offers ESG data, only 10 funds get a top-tier AAA ESG rating. And guess what? Only one of those has any sort of ESG component in the form of a focus on renewable energy. The rest are all focused on European countries, partially because ESG has a big head start in Europe and the boards of directors there reflect that.

If you step down a tier to the funds rated “AA,” there are only 83 ETFs meeting that criteria. And of those, less than a dozen are marketed as ESG funds. The “A” rating tier includes more than 400 funds, and not many of those funds are labeled as ESG or socially responsible either.

Investors can also use ETF.com’s screening tool to see how rated ETFs compare with their peers, their ESG quality rating and their carbon intensity score, among many other metrics.

You can construct a highly rated portfolio from an ESG perspective without even buying an ETF that mentions its socially responsible credentials in its name. The ESG waters can certainly be murky.