Environmental, social and governance (ESG) ETFs are hot nowadays, both with investors and with issuers. There are now over 100 products on the market, which have collected some $31.76 billion in investment assets—overtaking assets invested in traditional energy ETFs for the first time.
But not every ESG ETF is—or even can be—a billion-dollar baby, and increasingly, the success of an ESG ETF comes down to the size of the issuer whose name appears on the label. iShares alone has seen $11.1 billion of the $14 billion in new net flows entering ESG ETFs year-to-date. (Read: "Demand Hot For iShares ESG Funds.")
As a result, many differentiated, thoughtfully constructed ESG funds have failed to attract attention from investors, in part because their issuers lack BlackRock's marketing might or pool of BYOA cash. But that doesn't mean they aren't good opportunities.
We sorted through the ESG ETFs with fewer than $100 million in assets under management as of May 26, 2020, and pulled out some of our favorite hidden ESG gems.
Divest From Authoritarianism With FRDM
Emerging markets offer investors growth potential and diversification, but also an ethical quandary: How do you invest in developing economies without also funding authoritarian regimes?
The vast majority of emerging market ETFs continue to invest significant amounts of cash into the same problematic countries—China, Russia, Saudi Arabia, Brazil and others—even as these countries crack down on their citizens' freedoms. The Vanguard FTSE Emerging Markets ETF (VWO), for example, invests 54% of its portfolio in China, Russia, Saudi Arabia and Brazil, while the iShares Core MSCI Emerging Markets ETF (IEMG) invests 47%.
But it doesn't have to be that way. The Freedom 100 Emerging Market ETF (FRDM) offers an alternative approach that's unique among emerging market ETFs.
FRDM weights countries by their freedom levels, a nebulous-sounding concept that actually encompasses 79 separate metrics, touching on everything from a country's capital market structure and freedoms of its press to the extent of human trafficking within the country's borders. The top 10 freest countries are selected, and the top 10 largest, non-state-owned equities from those countries are included in the fund's index.
As a result, FRDM's portfolio has no exposure to China, Russia, Saudi Arabia, Brazil and other problematic countries, instead weighting heavily to Taiwan (24%) and South Korea (21%). Regionally, these countries' economies are tied to China's while still remaining distinct, thus providing FRDM with a slight cushion when Chinese stocks stumble.
For example, FRDM has outperformed VWO and IEMG over the past month by more than a percentage point, rising 3.6% compared to VWO's 2.4% and IEMG's 2.3%:
Source: ETF.com. Data as of May 28, 2020.
We'd be remiss if we didn't also point out FRDM won our award for the best new international ETF of 2019. (Read: "The Annual ETF.com Awards.")
Worried About Greenwashing? Try CHGX
One of ESG ETFs' most well-deserved criticisms, especially the broad market funds, is the issue of "greenwashing," or a seemingly lackadaisical approach to ensuring that the stocks in the portfolio actually adhere to the principles the ETFs purport to follow.
For example, many issuers have language in their funds' prospectuses about not investing in companies experiencing "severe business controversies," only to then include companies like Facebook (FB) or Amazon (AMZN) in their portfolios. (Facebook has blundered its way through privacy scandal after privacy scandal, while Amazon's record on labor rights is atrocious.)
The Change Finance U.S. Large Cap Fossil Fuel Free ETF (CHGX) isn't one of those funds. It's probably one of, if not the, most stringent ESG ETFs left on the market—an ETF made by true ESG believers, for true ESG believers.
CHGX is one of the few ESG U.S. equity ETFs where you won't find Tesla (TSLA), for example, or Facebook, Amazon, Exxon (XOM), McDonalds (MCD) or Uber (UBER)—or any other company that has had significant labor, privacy or environmental controversies in its recent past.
That's because, unlike some ESG ETFs that try to simply limit, rather than eliminate, their exposure to certain objectionable themes, CHGX puts its money where its proverbial mouth is and divests entirely from problematic stocks and sectors.
Take its approach to fossil fuels. Not only does CHGX exclude oil and gas producers—as do many other ESG ETFs—but it also excludes coal miners, oil and gas refiners, and processors and utilities that burn fossil fuels. Compare that to the SPDR S&P 500 Fossil Fuel Reserves Free ETF (SPYX), which only excludes companies that have fossil fuel reserves on hand; or the ProShares S&P 500 Ex-Energy ETF (SPXE), which cuts out the entire energy sector but leaves in fossil-fuel-consuming utilities (and everything else).