The Year In ESG ETFs

2018 was supposed to be the year environmental, social and governance (ESG) investing finally hit it big. Market experts—including this one!—predicted that this year, impact investing would finally reach its critical mass, and investment flows would begin to flood into the space.

That flood, however, ended up being more of a trickle.

As of Dec. 17, socially responsible ETFs had amassed $7.9 billion in assets under management, up from $4.8 billion at the start of the year.

While that represents a 63% year-over-year growth, $7.9 billion of assets is a mere drop in the bucket of the ETF industry, into which more than $3.5 trillion has been invested.

Anemic Flows Due To Mutual Funds

Interestingly enough, the general reluctance toward ESG ETFs may stem from their overwhelming popularity among mutual fund investors.

A recent report found that $12 trillion—one-quarter of all assets managed in the U.S.—were invested according to ESG principles. Much of that is invested in actively managed mutual funds.

Those assets have proven fairly sticky. ESG investors, driven by the conviction of their values, are willing to ride out periods of underwhelming performance, even those that might be driven by the higher costs associated with active management (read: "Where Are The ESG Flows?").

In addition, a significant minority of ESG ETFs—42%—are U.S. equity funds, a segment for which investors have shown little enthusiasm lately, particularly over the fourth quarter.

In contrast, international ETFs, such as the iShares ESG MSCI EAFE ETF (ESGD) and the iShares ESG MSCI EM ETF (ESGE), saw comparatively higher inflows. In fact, ESGD and ESGE brought in the most new net assets of any ESG ETF, at $371 million and $313 million, respectively.

New ESG ETFs Fail To Overwhelm

Sixteen new ESG ETFs launched this year, listed in the table below:

Sources: ETF.com, FactSet. Data as of Dec. 17, 2018.

Combined, these 16 ETFs brought in just $362 million in new investment dollars, 46% of which went into a single fund, the Goldman Sachs JUST U.S. Large Cap Equity ETF (JUST). (Though JUST took in $250 million on its first day, it has since lost a significant amount of those assets, netting just $166 million in flows for the year.)

Meanwhile, some of the more widely anticipated launches—BlackRock's gun-stock-free U.S. small-cap ETF, for example, or Vanguard's first ESG funds—failed to attract significant assets.

The iShares ESG MSCI U.S.A Small-Cap ETF (ESML) launched in the wake of national protests against gun violence and a surge of interest from investors in gun-stock-free investing. However, ESML has accrued barely more than $10 million in assets under management, placing it at right about its starting seed capital.

Vanguard's new ESG ETFs have proven more popular, but only slightly. The Vanguard ESG U.S. Stock ETF (ESGV)—which, at 0.12%, is also now the cheapest ESG U.S. equity ETF—has brought in $84 million in net inflows. Its international stock ESG ETF, the Vanguard ESG International Stock ETF (VSGX), brought in $57 million.

That's not bad for ETFs three months after launch, but at the same time, we're talking about Vanguard here, the second-biggest ETF issuer on the planet. If Vanguard can't make an ESG ETF into an overnight success, who can?

Lower Fees Draw Some Investors

Just as in other corners of the market, issuers of ESG ETFs are slashing expense ratios to lure additional investors. That's particularly welcome in the ESG space, given that these ETFs, often meant as replacements for core exposure, remain overwhelmingly more expensive than their vanilla counterparts.

In April, iShares slashed expense ratios on the iShares MSCI KLD 400 Social ETF (DSI) and the iShares MSCI U.S.A. ESG Select ETF (SUSA), which also happen to be the largest ESG ETFs, with $1.2 billion and $819 million in assets, respectively.

Afterward, DSI and SUSA brought in $219 million and $169 million, respectively, in new net flows—more than twice what either fund had brought in over the 12 months prior to the price drop.

Still, those flows aren't jaw-dropping, and low prices alone appear to have limited appeal. This year also saw the launch of the cheapest ESG fixed-income ETF (which is also the cheapest ESG ETF, period): the iShares ESG U.S. Aggregate Bond ETF (EAGG). Though well-seeded with $50 million, EAGG has only brought in $5 million since it launched in October.

Small, Narrow ESG ETFs Outperform

Performancewise, however, ESG ETFs tend to be doing fairly well. Year-to-date, 17 of the 26 U.S. equity ESG ETFs on the market have outperformed the SPDR S&P 500 ETF Trust (SPY), which has dropped 3.06%. Five of the seven global total market ESG ETFs are outperforming the Vanguard Total World Stock ETF (VT).

Sources: ETF.com. FactSet. Data as of Dec. 17, 2018.

It's worth noting that many of these funds are small and expensive, the latter of which tends to ensure the persistence of the former.

But many of these top performers are also laser-focused on a specific issue, e.g., founder-run companies, gender diversity in the board room, environmental services. When it comes to any sort of thematic fund, the evidence shows that the more targeted the investment objective is, the better the fund's performance tends to be.

That's especially true for the ESG space, where “greenwashing” has become more and more of a problem. Currently, many ESG ETFs use selection criteria that allow for portfolio holdings that don't always align with what investors might consider "socially conscious," including companies like Exxon-Mobil (XOM), Facebook (FB) or Coca-Cola (KO). Including these stocks in an ESG fund can achieve marketlike performance at the expense of the spirit of impact investing.

For purists, funds like the SerenityShares Impact ETF (ICAN) and the Change Finance U.S. Large Cap Fossil Fuel Free ETF (CHGX), which are run by ESG true believers, indeed may be overlooked gems.

Contact Lara Crigger at [email protected]