Your Stealth 'ESG' Portfolio

You may be active in social impact investing and not know it.

While the headlines may have died down a tad, the pace of environmental, social and governance (ESG) product launches (and the volume of ESG-related email and chat questions I get) hasn’t.

The last few years have shown that ETFs focused on ESG issues are here to stay. So how do you actually think about ESG factors in your portfolio?

Finding The Data

You may notice today a few tweaks in some of the ESG data we show here at ETF.com. MSCI just revamped its ESG methodology a touch, primarily by adopting a “bond style” letter grading system that makes it much easier to glance down a list of ETFs and see how they compare.

For instance, in the ETF.com finder, you can see these scores under the ESG tab. So let’s say you were looking at growth ETFs:

Sorted by the ESG rating, you can see that two funds stand out as “AA rated.” In MSCI speak, that means these funds are ESG leaders when all 37 key issues tracked by MSCI are considered, from the carbon footprint of the products made and sold by each company held in each ETF, to the pay structure of executives and the labor standards of each companies supply chain.

And while, yes, the top fund here is in fact an “ESG labeled” product from Nuveen, two of the funds that rate the very best here are in fact not making any claims about their “ESG-ness” at all!

So what’s going on here? It’s simple really—individual companies are what are measured, and that’s as it should be. No ETF issuer is making an impact simply by launching an ESG fund. The heavy lifting is done by the companies in the funds.

Sure, Nuveen in this case has built a methodology to specifically invest in as many of those companies as it can, but the iShares MSCI EAFE Growth ETF (EFG) here makes no such attempt, and yet it still earns an AA rating.

Checking Your Funds

Let’s approach the problem from another angle. Let’s say you’re invested in a typical portfolio of big, well-known ETF names. Your large cap exposure might be the SPDR S&P 500 ETF Trust (SPY). You can hop over to www.etf.com/SPY and find out all sorts of information, including this block under the “Fit” tab:

Here there are a few ways the data is telling you similar things. The “BBB” rating puts it firmly in average territory:

And in case you weren’t clear, the 59% percentile rank in its peer group, 54% among all funds, and 5.54 out of 10 on “quality” all point you to basically the same conclusion.

So what do you do with this information? Well, if you wanted to maintain your large cap exposure to the U.S. market, you could just go back to the ETF finder and look just at those funds, sorting based on the ESG score again:

And to me, what you find here is super interesting.

The winners in this segment aren’t ESG-centric funds. They are, well, the boring ones. For these ETFs tackling the U.S. market through the lens of long-term dividend growth or minimum volatility, their portfolios are actually quite diverse: Low-vol funds are currently loaded up on utilities and financials; dividend-focused funds tend to be overweight in industrials and consumer stocks.

Adding ESG To Your Due Diligence

The point here (and I do have one) is that you don’t have to jump into ESG investing with both feet to include it in your portfolio construction process. Sure, if how the companies you own treat people and the planet is your primary concern, by all means, have at it. There’s a whole micro-industry of ESG-branded ETFs at your fingertips.

But I suspect, for most investors, those concerns are just a part of a much more comprehensive process that includes everything from expenses to exposures.

So if you’re interested in ESG but unclear how to include it in your or your clients’ portfolios, consider just starting by measuring what you already own. You might be surprised to find that a few simple tweaks can make a big difference.

P.S. MSCI published a great piece conducting an analysis of the international ETF universe that’s worth a read too, here: Under The Hood: Rating ESG Funds.

For more information, see Introducing MSCI ESG Fund Ratings.

Dave Nadig can be reached at [email protected]