Biggest Environmental Funds Lose Top ESG Rating

The world’s biggest environmental, social and governance exchange-traded funds had their scores cut by the firm that doles out ESG rankings, after stricter, new criteria recategorized the funds. 

The biggest ESG exchange-traded fund, BlackRock Inc.’s $13.3 billion iShares ESG Aware MSCI USA ETF (ESGU) was trimmed to AA from AAA by MSCI, an index provider that also grades ETFs based on their compliance with ESG standards. The No. 2 ESG fund by assets, the $7.34 billion iShares ESG Aware MSCI EAFE ETF (ESGD) was similarly trimmed. 

MSCI said in March it was tightening the criteria on what makes an ESG fund earn an AAA rating, and that may result in 31,000 funds having their ratings cut. New York-based MSCI said at the time that the changes were made in response to feedback from market participants, who had noticed “an upward drift in ratings across the fund universe.”

At the same time, ESG investing had become a political football of sorts, with left-leaning politicians generally favoring rules that force investing some government pension money into funds that aim to curb greenhouse gas emissions, and those on the right pushing bans on the practice.

The ratings have also been criticized for confusing, rather than clarifying, the ESG impact of a fund or a company. Ratings have also been attacked for being inconsistent and unregulated.

Last June, the Securities and Exchange Commission issued a request for comment to gauge the need to impose tougher standards on providers such as S&P Global, MSCI and FTSE Russell, who provide underlying indexes for many ETFs.

“Downgrades like this are a recognition of market immaturity and dysfunction,” Leon Saunders Calvert, chief product officer at U.K. researcher ESG Book, wrote in an email to etf.com. “The downgrades are likely to also accelerate changes in how individual assets are rated.” 

European Union regulators have also tightened guidelines in response to criticism.

An MSCI rating might make a difference in whether or not an institutional investor selects one fund over another. According to the firm, the ratings provide a due diligence function: In addition to gauging the ESG impact of a particular fund, they help financial advisors and wealth managers find ETFs that line up with client values. 

A complete analysis of all ESG funds and downgrades wasn’t immediately possible, with etf.com data listing 206 ESG funds. 

Rounding out the largest three ESG funds, the $6 billion Vanguard ESG U.S. Stock ETF (ESGV) was cut to A from AA.

The downgrades were first reported by Bloomberg News. 

Contact Ron Day at [email protected] or follow him on Twitter at @RonDayETF