Mainstream Using ETFs In ESG Pivot

[This article appears in our April 2021 issue of ETF Report.]

Environmental, social and governance (ESG) investing through ETFs is just getting started, and it’s not solely because people want a warm, fuzzy feeling when they invest. ESG investing is about sustainability and, as BlackRock CEO Larry Fink put in his 2021 letter to CEOs, “creating durable value.”

I would argue that ESG as an investment theme serves a very practical purpose, and it’ll play an integral role in the future of capitalism.

Burgeoning Acceptance
Nearly 60% of companies are feeling pressure from stakeholders—especially from employees, board members and customers—to address climate risk, a 2020 report from Deloitte found. Climate change is a key aspect of the environmental pillar in ESG.

In that same report, millennials, the youngest generation surveyed, were consistently very concerned about climate change, suggesting that’s the way forward. And a 2019 study conducted by Amundi found that better ESG scores resulted in better stock market performance overall, with environmental scores being of particular importance in the U.S.

When considering the social aspect of ESG, one standout topic and point of evaluation is the issue of diversity. This is logical, because actively seeking a wider pool of candidates to draw from means finding the “perfect” fit is more likely. The same goes for supporting female and minority staff members, which can lead to greater retention of talent. Studies back this up as well.

A 2018 report from McKinsey & Co. found that top-quartile companies in gender diversity at the executive level had significantly better performance in profitability, and that was even truer for companies in the top quartile for ethnic and cultural diversity. Meanwhile, the study found bottom-quartile companies in diversity were nearly one-third less likely to outperform in terms of profitability.

Governance is the “no brainer” part of ESG. Well-run companies are generally going to perform better, and governance is also the most quantifiable pillar of the ESG triumvirate.

An S&P research piece from 2019 notes that the data for governance generally goes back further than for the environmental and social elements, and that those criteria and standards are the most widely accepted and discussed. Governance includes core areas like codes of business conduct, risk or crisis management, supply chain management and tax strategy.

The trouble with ESG investing is that it’s typically been seen as an underperformer. But we’re seeing instances of outperformance compared with conventional funds. For example, BlackRock found that 94% of sustainable indices outperformed conventional counterparts in the first quarter of 2020, when world markets were hit hard by coronavirus.

Hard Data Is Key
ESG’s roots lay in the late 20th century, and early adopters were more driven by deeply held moral values than anything else. However, ESG investing has become even more grounded in hard data than it was before, and there’s been more of a drive in recent years to ensure that investors don’t miss out on performance to any significant  degree. It’s no longer a given that investing in an ESG strategy means one must accept that their investment will trail the parent index or a similar conventional strategy.

ESG is about building better businesses that can adapt to current realities and needs while having a beneficial impact on the wider world. With concepts like climate change and globalization claiming more attention on the world stage, socially responsible investing cannot simply be dismissed as some sort of “hippie” concept centered on generating positive vibes.

As noted earlier in the issue, ESG strategies already represent one-third of total U.S. assets under management. That’s no passing fad.