Fossil Fuel Free ETFs That Aren't

Most clean energy funds still invest in Big Oil and Big Coal—and it hurts their returns.

Clean energy remains the most popular theme among environmental, social and governance (ESG) ETFs. Nearly two-thirds, or 64%, of the $6.3 billion currently invested in them are held in funds carrying some kind of screen for greenhouse gas emissions or for involvement in the coal, oil and natural gas industries.

Yet the vast majority of these ETFs still invests in the users and producers of fossil fuels—even the ones marketing themselves as being fossil fuel free.

Weightings in "dirty energy" companies range from 1.73% held by the Etho Climate Leadership U.S. ETF (ETHO) to 18.34% held by the Columbia Sustainable U.S. Equity Income ETF (ESGS).

Even ETFs marketed specifically for their avoidance of companies involved in fossil-fuel-related activites, such as the SPDR S&P 500 Fossil Fuel Reserves Free ETF (SPYX), still hold companies in oil, coal and natural gas: SPYX, for example, holds 5.72% of its portfolio in oilfield services firms and coal-fired utilities.

Worst Offenders

We compared the 65 socially responsible ETFs to the Fossil Free Funds' database, which allows investors to search more than 3,000 mutual funds and ETFs for holdings in oil/gas E&P firms, coal producers, fossil-fuel-fired utilities and other "dirty energy" sources.

Fossil-free funds designates a stock as a fossil fuel company using Morningstar industry classifications and third-party proprietary research on fossil fuel reserves, emissions output and more.

Although at least 31 ESG ETFs screen for greenhouse gas emissions and/or company involvement in fossil fuels, only six funds had portfolios completely free of fossil-fuel-related firms.

Sources: ETF.com, FactSet, Fossil Free Funds. Data as of March 12, 2018.

The 10 ESG ETFs with the highest concentration of fossil fuel stocks in their portfolios are listed below:

Sources: ETF.com, FactSet, Fossil Free Funds. Data as of March 12, 2018.

No Performance Boost From Dirty Energy

What's remarkable about these results is there appears to be no clear performance advantage to including fossil fuel energy companies in an ESG portfolio.

None of these 10 ETFs with outsized "dirty energy" allocations is among the top-10-performing ESG ETFs over the past 12 months. In fact, most of the top 10 performers had extremely low weightings in fossil fuel companies—two had no allocation to them at all:

Sources: ETF.com, FactSet, Fossil Free Funds. Data as of March 12, 2018.

At the same time, four of the ETFs with the highest allocations to fossil fuel companies—FAN, ESGS, ICLN and NULV—were also among the 10 worst one-year-performing ESG ETFs. An additional one, ESGW, was the eleventh-worst one-year performer:

Sources: ETF.com, FactSet, Fossil Free Funds. Data as of March 12, 2018.

Rather than conventional energy firms adding a boost to ESG ETF returns, as many might assume, it is in fact the opposite: Conventional energy companies drag down performance of ESG ETFs that include them. The higher an ESG ETF's weighting in "dirty energy," the worse its returns become.

In large part, this is because the conventional energy market, driven by oil and natural gas producers, has vastly underperformed the broader market on a 12-month basis. For example, the Energy Select Sector SPDR Fund (XLE), which tracks the Big Oil giants, is only up 0.85% on a one-year basis; in contrast, the SPDR S&P 500 ETF Trust (SPY) is up 20.02%.

Fossil-Fuel-Free Funds That Aren't

Intriguingly, although four ESG ETFs are specifically marketed on their avoidance of fossil fuel stocks, even containing the words "fossil fuel" and "free" in their fund names, only one was actually free of any fossil fuel-related companies—the Change Finance Diversified Impact U.S. Large Cap Fossil Fuel Free ETF (CHGX).

Meanwhile, the SPDR S&P 500 Fossil Fuel Reserves Free ETF (SPYX) has a 5.72% weighting in 37 fossil fuel companies, including Valero Energy, Halliburton and Schlumberger, an oilfield services company.

The SPDR MSCI Emerging Markets Fossil Fuel Reserves Free ETF (EEMX) and the SPDR MSCI EAFE Fossil Fuel Reserves Free ETF (EFAX) had a 2.87% and 4.13% weighting, respectively, to fossil fuel companies.

To be fair, "fossil fuel reserves free" is not the same as "fossil fuel free." Indexes excluding companies holding reserves of oil, coal and natural gas typically end up screening out energy producers, but they may still hold oilfield services companies or utilities that still use coal- or natural-gas-fired plants.

Still, it's a semantic nuance many investors may not be aware of, and in fact, for the first six months of its life, SPYX traded under the name "SPDR S&P 500 Fossil Fuel Free ETF,” even though it held fossil-fuel-related companies. SPYX added the "Fossil Fuel Reserves Free" clarification in August 2016.

Big Oil As Big Renewables

Though at first it may seem counterintuitive, it isn't all that surprising that ETFs in the clean energy space would contain some exposure to Big Oil and Big Coal—after all, these companies have made and continue to make considerable investments into green technology.

Oil producers like Chevron, Royal Dutch Shell and BP have invested billions into corn-based ethanol biofuels and hydrogen fuel cells. Utilities like NextEra Energy are transitioning from coal- and natural-gas-fired plants to solar and wind to constrain costs. Oil giant Exxon Mobil even makes lubricants for wind turbines.

Meanwhile, pure-play renewable energy companies are rare. Those that do exist tend to be small-caps, falling outside the scope of many broad-based ESG ETFs, which are large-cap funds specifically designed to provide marketlike exposure.

Some investors are excited by how conventional energy firms have been tiptoeing into clean energy. Others still want nothing to do with Big Oil and Big Coal. That's why it's so important to set aside the marketing-speak and open up the hood of your ESG ETF to see what's inside and how it came to be there. Otherwise, you might find yourself holding something you least expect.

Contact Lara Crigger at [email protected]