Is Lack Of Energy Hurting ESG ETFs?

Key Takeaways

• Many environmental, social and governance (ESG) ETFs are designed to provide similar sector exposure to the broader equity market, limiting the underweighting to energy and overweighting to information technology.
• Such diversification helped the iShares ESG Aware MSCI USA ETF (ESGU) and many of its broad ESG peers keep up with the return of the iShares Core S&P 500 ETF (IVV) in 2021.
• The six largest broad ESG ETFs pulled in $2.7 billion year-to-date through March 12 and more than $13 billion in the past year to reach $31 billion in assets.

Fundamental Context

Broad ESG ETFs’ similarity to the S&P 500 Index helped weather the recent style rotation. The Energy Select Sector SPDR Fund (XLE), which tracks the S&P 500 Index’s energy sector, was up a whopping 41% year-to-date through March 12, erasing its 33% loss in 2020. In contrast, the Technology Select Sector SPDR Fund (XLK) rose just 1.1% this year, on the heels of an impressive 41% gain last year.

In 2021, investors rotated to more cyclical value-oriented sectors, from growth ones, amid higher bond yields and favorable signs of an improving economy. While some investors think of ESG ETFs as solely based on the environmentally friendly pillar and presume there is little to no energy exposure, the most popular U.S. ESG ETFs look a lot like the broader equity market from the top down..

Despite a strong run so far in 2021, energy represented just 3.0% of assets in IVV, just barely larger materials, utilities and real estate sectors. IVV’s energy weighting was just 10 basis points more than that of the $15 billion ESGU, the largest broad ESG offering, but 10 basis points less than the $510 million Xtrackers S&P 500 ETF (SNPE). Indeed, the two ESG ETFs own Chevron (CVX) and Exxon Mobil (XOM).          

Meanwhile, IVV’s 26% stake in information technology stocks was 150 basis points less than ESGU’s and 200 points less than SNPE’s. Apple (AAPL) and Microsoft (MSFT) are the top two positions in IVV and the two ESG ETFs, though the weights are different.

Sector Exposure Of Broad ESG ETFs

Source: CFRA’s First Bridge ETF Database, as of March 12, 2021

Strengthening Performance, Popularity

The performance differential between ESG ETFs and the S&P 500 is also minimal. Focusing on the six largest broad ESG ETFs with a U.S. focus, three modestly outperformed IVV’s 5.4% year-to-date gain through March 12 and three modestly underperformed.

The iShares MSCI KLD Social 400 ETF (DSI) rose the most, climbing 5.9%, followed by 5.8% and 5.5% gains for the Xtrackers MSCI U.S.A. ESG Leaders ETF (USSG) and the iShares ESG MSCI Leaders ETF (SUSL), respectively. In contrast, ESGU and the iShares MSCI USA Select ETF (SUSA) both increased 5.3%, while the Vanguard ESG U.S. Stock ETF (ESGV) climbed 4.9%; the more moderately sized SNPE also rose 4.9%.

Year-to-Date Performance Of Broad ESG ETFs (%)

Source: CFRA’s First Bridge ETF Database, as of March 12, 2021

ESG ETF popularity has continued in 2021. The six broad ESG U.S. equity-focused ETFs with the most assets collectively manage $31 billion, aided by a combined $2.7 billion of net inflows year-to-date, led by ESGU ($890 million) and ESGV ($542 million).

Investors are increasingly using these ETFs as a replacement for market-cap-weighted S&P 500 exposure in asset allocation portfolios, seeking to achieve financial goals and support the environment, society and good governance. We think the modest expense ratios of 0.25% or less have added to the appeal of these products.

Conclusion

Some investors have a false impression that they need to give up marketlike returns when prioritizing doing good. However, broad ESG ETFs were built to serve as the potential core of the portfolio by choosing companies with relatively strong ESG attributes within a sector. CFRA thinks many of them also have a high likelihood of outperforming over the next nine months.

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