ESG ETFs In 2019: Institutions Buy In

Was 2019 the year environmental, social and governance (ESG) ETFs finally went mainstream?

In a word: No.

As of Dec. 17, socially responsible ETFs had attracted a little over $8.6 billion in inflows for 2019, a 10% year-over-year rise and a paltry sum compared with the $290 billion investors have added to ETFs as a whole (read: "The Year In ESG ETFs").

So why are many market observers still so optimistic on ESG ETFs?

Because this year something was different: Institutional interest defined ESG flows in a way they never have before. So while flows into ESG ETFs might yet be a trickle, it's one that promises to turn into a tide as client demographics shift, climate change worsens and industry ESG mandates become more widespread.

Notable—But Not Many—Outflows

In 2019, flows into ESG ETFs remained modest, despite several notable launches with billion-dollar buy-in.

That said, few ESG ETFs actually lost money this year. Three notable exceptions include the Goldman Sachs JUST U.S. Large Cap Equity ETF (JUST), the iShares MSCI ACWI Low Carbon Target ETF (CRBN) and the SPDR SSGA Gender Diversity Index ETF (SHE), which saw outflows of $87 million, $94 million and $218 million, respectively.

Interestingly, all three funds had been seeded or funded early on with institutional cash; and each fund saw outflows representing approximately most or all of that initial investment. Their outflows could be interpreted as a loss of faith from their original institutional backers.

These examples aside, though, most ESG ETFs ended 2019 in the black. Still, outside a handful of broad-based U.S. equity ETFs, few funds actually amassed any significant new net assets. Most ESG ETFs—60 out of 93 funds (almost two-thirds), brought in less than $100 million of net inflows for the year.

Unexpected Horse Race

There were a handful of success stories, however. Probably the most-talked-about ESG event of 2019 was the one nobody saw coming: a horse race between two new broad-based U.S. equity ETFs, the Xtrackers MSCI U.S.A. ESG Leaders Equity ETF (USSG) and the iShares ESG MSCI USA Leaders ETF (SUSL).

Funded out of the gate with hundreds of millions of dollars by Finnish insurer Ilmarinen, both USSG and SUSL catapulted past $1 billion in assets shortly after their launch and stayed there throughout 2019. In fact, SUSL attracted funds so quickly it became the third-fastest ETF to surpass $1 billion in assets under management (read: "New ETFs Join $1B Club Quickly").

SUSL currently has $1.7 billion in AUM, while USSG has $1.6 billion. They're now the second- and third-largest ESG ETFs on the market, behind the $1.8 billion iShares MSCI KLD 400 Social ETF (DSI), the perennial stalwart of the space.

SUSL and USSG track nearly identical indexes of U.S. large- and midcap stocks drawn from the MSCI USA Index. They implement similar ESG screens to weed out controversial companies, such as those involved in tobacco, alcohol, gambling and civilian firearms.

Far from thematic plays, SUSL and USSG offer marketlike exposure, making them suitable to swap for some or all of one's vanilla U.S. equity exposure—thus targeting institutions looking to satisfy ESG mandates.

Organic Flows Into Vanguard Products

As large as the flows into SUSL and USSG were, they remained choppy throughout the year, with only a handful of trades executed mostly in large block sums. It seems neither fund has yet attracted much in the way of interest from smaller investors.

Meanwhile, Vanguard's two ESG ETFs have seen much more organic flows. The Vanguard ESG U.S. Stock ETF (ESGV) and the Vanguard ESG International Stock ETF (VSGX), both of which launched in  September 2018, have consistently drawn daily flows of $10 million to $20 million all year (read: "Institutional Money Comes To ESG ETFs").

ESGV brought in $634 million in 2019, while VSGX has brought in $482 million.

Demand has also been strong for the iShares ESG MSCI U.S.A. ETF (ESGU), which had a few days of multimillion-dollar creations in September, but which has seen steady, smaller trades in the months before and since. ESGU now stands at $1.4 billion in AUM (read: "Demand Hot For iShares ESG Funds").

Investors Lose Interest In Thematic Funds

2019 saw only a handful of thematic launches, such as the freedom-weighted Alpha Architect Freedom 100 Emerging Markets ETF (FRDM) in May and the U.S. Vegan Climate ETF (VEGN) in September. There was also the launch of the first ETF compliant with Islamic religious principles (known as Shariah law), the Wahed FTSE USA Shariah ETF (HLAL).

Intriguingly, there were more thematic ETFs that closed this year than opened. Two LGBTQ-friendly ETFs closed, including the Workplace Equality Portfolio ETF (EQLT) and the InsightShares LGBT Employment Equality ETF (PRID).

Other funds that shut up shop included renewable the energy-focused Invesco WilderHill Progressive Energy ETF (PUW) and a biblically aligned fund, the James Purpose Based Investment ETF (JPBI).

New Launches Target Asset Allocations

On the whole, most new ESG ETF launches were more like USSG or SUSL; that is, products designed to slot neatly in investors' traditional, broad-based asset allocations. For example, the Nuveen ESG Large-Cap ETF (NULC) or the Xtrackers S&P 500 ESG ETF (SNPE) won't set any hearts or minds on fire, perhaps, but they are designed to function nicely as socially responsible replacements for traditional S&P 500 Index ETFs.

Notably, a few ESG bond ETFs also launched in 2019, filling out a segment sorely lacking in options for investors.

In September, the Nuveen ESG High Yield Corporate Bond ETF (NUHY) launched as the first ESG junk bond ETF; while just last week saw the debut of the actively managed PIMCO Enhanced Short Maturity Active ESG ETF (EMNT), the first to cover short-term bonds.

2020: Year For Innovation?

What comes next in ESG? We hesitate to make too many predictions, but if filings are any indication, issuers may spend the next few months in a holding pattern, waiting to see which, if any, of the many funds that launched in 2019 will take off with investors.

Filings in the pipeline for new funds are few and far between, though there are still a few notable offerings yet to launch. For example, in September, State Street filed for its own line of ESG bond ETFs, as well as growth and value ESG funds.

Then in November, Direxion filed for a long/short strategy that would go long on highly rated ESG stocks, while shorting low-rated ones (read: "ETF Filings: Long/Short ESG & Treasury Ladders").

That said, with a contentious election coming up and a freshly impeached president, ESG issues are going to loom larger than ever in U.S. investors' minds—making 2020 perhaps an ideal year for issuers and investors alike to get into the game.

Contact Lara Crigger at [email protected]