Cheapest ESG ETF Portfolio Gets Cheaper

January 10, 2019

Last year, we put together the "World's Cheapest ESG ETF Portfolio," a socially responsible twist on former ETF.com CEO Matt Hougan's regular feature, in which he built a broadly diversified portfolio using the least expensive U.S.-listed ETFs in each of six asset classes (read: "World's Lowest Cost Portfolio Hits 0.05% Fee").

Our Cheapest ESG ETF Portfolio, which cost just 0.21%, wasn't supposed to be an investable guide. Rather, it served as a yardstick to gauge how the fee wars have impacted environmental, social and governance funds, which historically have cost more than conventionally structured ETFs.

However, a lot has changed since we first published that article. Late last year, the ETF leader in the space, BlackRock, lowered prices on a number of its socially responsible ETFs, while Vanguard, the 800 lb. gorilla of ultra-low-cost investing, finally entered the ESG space as well.

As a result, the overall cost of our Cheapest ESG ETF Portfolio has dropped considerably. The model now just costs 0.167%.

Building An ESG ETF Portfolio

To construct the portfolio, we opted for the cheapest ESG ETFs in each of six asset categories, giving no consideration to index, liquidity, assets under management or even trading costs. Expense ratio was our sole guide.

The resultant portfolio provides exposure to more than 2,500 stocks from 35 countries, as well as 178 U.S.-domiciled bonds. What's more, its blended expense ratio of 0.167% costs less than a third of the average equity ETF (0.54%):

 

Cheapest ESG ETF Portfolio, January 2019  
Asset Class Weight Fund Ticker Expense Ratio MSCI ESG Score
U.S. Equity 40% Vanguard ESG U.S. Stock ETF ESGV 0.12% 5.48
Developed Markets Equity 30% Xtrackers MSCI EAFE ESG Leaders Equity ETF EASG 0.14% 7.65
Emerging Markets Equity 5% iShares ESG MSCI EM ETF ESGE 0.25% 5.91
Fixed Income 15% iShares ESG U.S. Aggregate Bond ETF EAGG 0.10% N/A
REITs 5% U.S. Diversified Real Estate ETF PPTY 0.53% 3.01
Commodities 5% SPDR Kensho Clean Power ETF XKCP 0.45% 5.41
           
    Blended Expense Ratio   0.17%  

 

New Kids On The Block

Since last year, there are several new constituents in the portfolio. For starters, the $116 million Vanguard ESG U.S. Stock ETF (ESGV) is now the cheapest ESG-based U.S. equity ETF; with an expense ratio of 0.12%, it costs 0.03% per year less than our previous pick, the iShares ESG MSCI U.S.A. ETF (ESGU).

ESGV, which launched in September, also has a broader selection universe than ESGU. Whereas the BlackRock fund focuses primarily on large- and midcap stocks, ESGV pulls from companies across the size spectrum, quadrupling the number of stocks held.

For developed-market equity exposure, we turned to the $7 million Xtrackers MSCI EAFE ESG Leaders Equity ETF (EASG), a fund that launched last September. Costing just 0.14%, EASG is much less expensive than than our previous selection, the iShares ESG MSCI EAFE ETF (ESGD), which costs 0.20%.

EASG tracks the MSCI EAFE ESG Leaders Index, which applies ESG screens and rankings to the well-known MSCI EAFE Index. EASG has a deeper investment universe than ESGD; however, the top country rankings between the two funds remain largely the same. 

For emerging markets exposure, the $423 million iShares ESG MSCI EM ETF (ESGE), which costs 0.25%, is still the cheapest-in-class. Notably, no new ESG ETFs have launched in this space, which has largely fallen out of favor with investors, especially given the trade-related trouble currently roiling China's markets.

More Green Bond ETFs

The second half of 2018 saw the launch of several new green bond ETFs, both domestic and global. Cheapest among these was the iShares ESG U.S. Aggregate Bond ETF (EAGG), a green-screened version of the Bloomberg Barclays U.S. Aggregate Bond Index (the "Agg"), which costs just 0.10%.

EAGG screens the corporate and government bonds in its mix for ESG factors, such as the issuers' involvement in tobacco, weapons and "severe business controversies." The remaining portfolio is then optimized to maximize its overall average ESG score, while maintaining marketlike exposure.

It's a similar approach to our previous pick for the asset class, the NuShares ESG U.S. Aggregate Bond ETF (NUBD). However, NUBD, at 0.20%, costs twice what EAGG does.

Branching Out: Real Estate, Commodities

For real estate and commodities, neither of which has yet seen the launch of any ETFs purely marketed as "ESG," we once again opted for what we considered the next closest thing.

At least one real estate ETF uses ESG criteria in its selection process, even if it isn't the primary criterion: the U.S. Diversified Real Estate ETF (PPTY), which costs 0.53%.

The fund's provider, Vident, is known for its "principles-based investing" approach, and as part of its methodology, the firm excludes any REIT with "significant governance concerns," as defined by external management and a low free-float percent. These two indicators, argues Vident, tend to lead to a higher risk of conflicts of interest and misalignment of management and shareholders.

Regarding commodities, we opted for one of the many equity-based renewable energy ETFs on the market: the SPDR Kensho Clean Power ETF (XKCP). XKCP, which launched in October and costs 0.45%, undercuts our previous selection, the iShares Global Clean Energy ETF (ICLN), by 0.02%, which carries a 0.47% expense ratio.

XKCP uses a selection process guided by machine-learning to pick companies involved in renewable energy technology, products and services.

Even Cheaper ESG ETF Portfolios

Let's say you don't accept the above fudges for real estate and commodities; we can reroute the 10% of the portfolio that would have gone into these two asset classes into cash instead. As a result, the cost of our all-ESG ETF portfolio would fall to just 0.12%:

 

Cheapest ESG ETF Portfolio (Cash Allocation)
Asset Class Weight Fund Ticker Expense Ratio MSCI ESG Score
U.S. Equity 40% Vanguard ESG U.S. Stock ETF ESGV 0.12% 5.48
Developed Markets Equity 30% Xtrackers MSCI EAFE ESG Leaders Equity ETF EASG 0.14% 7.65
Emerging Markets Equity 5% iShares ESG MSCI EM ETF ESGE 0.25% 5.91
Fixed Income 15% iShares ESG U.S. Aggregate Bond ETF EAGG 0.10% N/A
Cash 10%        
    Blended Expense Ratio   0.12%  

 

Or if instead we use a classic 60/40 split, with 60% in stocks and 40% in bonds, then the World's Cheapest ESG ETF Portfolio's blended cost falls to 0.13%:

 

Cheapest ESG ETF Portfolio (60/40 version)
Asset Class Weight Fund Ticker Expense Ratio MSCI ESG Score
U.S. Equity 30% Vanguard ESG U.S. Stock ETF ESGV 0.12% 5.48
Developed Markets Equity 20% Xtrackers MSCI EAFE ESG Leaders Equity ETF EASG 0.14% 7.65
Emerging Markets Equity 10% iShares ESG MSCI EM ETF ESGE 0.25% 5.91
Fixed Income 40% iShares ESG U.S. Aggregate Bond ETF EAGG 0.10% N/A
           
    Blended Expense Ratio   0.13%  

Tables sources: ETF.com, FactSet; data as of Jan. 7, 2019

 

Cost Isn't Everything

It's important to remember that the Cheapest ESG ETF Portfolio is one thing and one thing only: cheap. While it's easy to lose yourself in bargain hunting, cost alone tells you nothing about a fund's performance, liquidity, volatility, associated risks and so on.

Furthermore, many of the funds in this portfolio are less than three months old. That means they've yet to accrue much in the way of assets or track record, and they can be illiquid and hard to trade. In fact, only one of the ETFs in our model, ESGE, has yet managed to break the $100 million in AUM liquidity threshold.

Still, despite popular wisdom, inexpensive ESG ETFs do exist, options that are subject to the same fee pressures pushing down costs elsewhere in the ETF market.

Given the additional legwork involved in constructing an ESG ETF, the cost of our World's Cheapest ESG ETF Portfolio may never hit single digits. But all things considered, we think 0.17% is still pretty darn good.

Contact Lara Crigger at [email protected]

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