Evaluating Sustainability ETFs With MSCI

I’ve been a big proponent of the rise of environmental, socially responsible and governance (ESG) investing in ETFs. At this year’s Inside ETFs conference, I spent a solid chunk of the keynote talking about how ESG was coming, and how it was going to stick around.

I stand behind that reasoning. The core of the story goes like this: We’re in the middle of a $30 trillion intergenerational wealth transfer from baby boomers to their children. And those kids—not really “millennials” only, but people from 25-40 years old, simply think about their investment decisions differently.

Some of it’s obvious (they love ETFs, they love technology), but they also consistently say they want their money not just to earn something, but to do something.

Honestly, there’s a lot of work for the whole industry to do still in helping this new investor class put their money where their survey responses are. I’m excited today to talk about one small way ETF.com and MSCI can help.

MSCI On ETF.com

As of right now, when you’re looking for an ETF in our screener, or when you’re simply looking at most ETF fund pages (like, say, SPY), you can now see a selection of MSCI’s ESG ratings data.

First, here’s where you can find the MSCI data on the screener:

When you click on that tab, you’ll find the core ESG metrics for whatever group of funds you’ve been filtering for:

Here, you can also rank and sort the results by each MSCI metrics.

You’ll also find these same six metrics on every ETF report page where MSCI has calculated scores (in order for a fund to be scored, MSCI must have ESG data on 65% of the underlying securities by weight of a given fund). Let’s look at SPY as our test case. You can find these stats on the right-hand column, under the "FIT" tab:

A Word About Methodologies

I think any ESG approach is firmly into the “smart beta” part of the financial world. Most ESG factors are simply that—factors—and most factor approaches used in constructing smart-beta indexes work the same way: They take every stock in a given universe, and assign that stock some numerical value to capture its exposure to that factor.

For instance, if a stock has a low price-to-book ratio, a given methodology might score it “high” for value. That same stock might happen to also have been on a consistent upswing, so might currently score “high” for momentum. Various indexes can then be created, selecting and weighting that universe of stocks based on their exposure to the factor.

Factors can also be used analytically. Any given collection of stocks will have a certain collective “value-ness” or “momentum-ness,” which lets you make comparisons between portfolios.

ESG is no different: ESG factors can be used either to construct indexes, or to analyze portfolios, and in our case, that’s what we’re focused on.

Big Picture

MSCI’s approach is pretty straightforward. It looks at some 11,800 issuers of both equity and bonds, across more than 400,000 individual securities. At the issuer level, they look at dozens and dozens of metrics around environmental issues, social and impact investing, and good governance practices. These metrics can be thought of both in positive and negative ways.

For example, one of the inputs into the “environment” category is “climate change.” Climate change can be either a risk to a business or an opportunity, and the MSCI methodology measures both. All these various measures are rolled up into a single “ESG Fund Quality Score” for every fund, which is a finger-in-the-wind test of how the holdings in that fund stack up overall.

In the case of SPY, in the example above, the fund gets a 4.95 out of a possible 10 points for overall ESG quality. This makes intuitive sense, since most of us think of the S&P 500 as a kind of total-market proxy anyway, so you’d expect it to be pretty average.

The next two numbers put this score in context. The “Peer Group” rank likes SPY up against all of its peers (in this case, determined by Lipper’s very-broad classification system), and puts it in percentile order.

So, in this case, SPY is actually better than median when it comes to broad U.S. equity funds. The global score puts it in universal context—it’s actually worse than median compared with all the funds in the coverage universe. Again, given that, in general, European stocks do significantly better on ESG metrics, this makes intuitive sense.

Nitty-Gritty

The next three metrics provide three different angles on what ESG might mean to you.

The first, “SRI Screening Criteria Exposure,” tells you the percentage of the fund by market cap in “sin stocks”—stocks that would fail a socially responsible investing screening test. That’s subjective, of course, but the methodology here flags companies with significant exposure to alcohol, civilian firearms, gambling, weapons, cluster bombs, landmines, nuclear power, GMOs and tobacco. So that’s 11.95% of the S&P 500 by weight.

The flip side of the “bad stock” model is the “good stock” model, which MSCI calls “Sustainable Impact Solutions.” These are firms with exposure to things like clean energy, community development, or sanitation and affordable housing, on a revenue basis. The S&P 500, overall, has about 5.96% exposure to these positive-impact themes.

Last is a very specific number about carbon intensity. It’s actually telling you the weighted average carbon emissions per $1 million in sales. That’s not exactly a dinner-table talking point, but it’s fantastic for trying to understand the carbon footprint impact difference between portfolios.

That lets us compare SPY’s baseline of 209 tons with, say, the iShares MSCI USA ESG Select ETF (KLD), at 85, and the Energy Select Sector SPDR (XLE) at 479, and see the impact our portfolio companies are really having on the environment.

A Good First Step

Whether or not you consider yourself an ESG investor, I’m a firm believer in knowing what you own, and why you own it. ESG investing is, in many ways, still a nascent corner of the investing universe, much less the ETF market. The first step, however, is simply awareness.

Over the next few months, I plan on coming back to this data to see if it can help inform the ETF due diligence process in surprising ways. I’m also keen to dig even further under the hood in specific areas, and tease out why certain funds score the way they do.

I’m excited to be able to showcase MSCI’s ESG data here at ETF.com. Play around with it. Ask questions. See how your portfolio stacks up.

At the time of writing, the author owned none of the securities mentioned. You can reach Dave Nadig at [email protected].