ESG investments are getting hot. So far in 2020, investors in ETFs appear to be showing a growing preference for investments that follow ESG (Environmental, Social & Governance) criteria, some of which represent disruptive technologies. As evidence of this, new 52-week highs were reached in daily trading by the Vanguard ESG U.S. Stock ETF (ESGV) and the iShares ESG MSCI USA Leaders ETF (SUSL).
- ESG-focused ETFs from iShares and Vanguard have hit 52-week highs.
- Big tech firms tend to dominate the portfolios of ESG funds.
- "Green" technologies and practices are only part of the selection criteria.
Significance For Investors
ESG investing exploded in 2019 as a record $20.6 billion flowed into the sector via mutual funds and ETFs. That's nearly four times the previous record in 2018. While still a fraction of investable assets, more and more money managers, global banking giants, and philanthropic investors are setting hard and fast rules about not funneling more money to companies or funds that include fossil fuel stocks, boards that lack diversity, and companies that are not contributing to sustainability goals.
BlackRock Inc. (BLK), the world's largest investor with $7 trillion in assets, recently announced it would no longer invest in coal companies and reduce its exposure to companies that emit excess carbon. State Street Global Advisors, a division of State Street Corp. (STT) and one of the largest issuers of ETFs with $1.7 trillion in assets under management (AUM), recently followed suit. BlackRock is the sponsor of the iShares line of ETFs, while State Street offers SPDRs.
The Vanguard ESG U.S. Stock ETF (ESGV) has nearly $1.1 billion in AUM and an expense ratio of 0.12%. Its top four holdings are Apple Inc. (AAPL), Microsoft Corp. (MSFT), Amazon. com Inc. (AMZN), and Alphabet Inc. Class C (GOOG).
The iShares ESG MSCI USA Leaders ETF (SUSL) has over $1.9 billion in AUM and expense ratio of 0.10%. Its top four holdings are Microsoft Corp. (MSFT), Alphabet Inc. Class C (GOOG), Alphabet Inc. Class A (GOOGL), and Johnson & Johnson (JNJ).
Meanwhile, a recent study by RBC Capital Markets indicates that funds which tout an adherence to ESG investment principles are highly tech-oriented in their holdings. Specifically, the five most commonly-held S&P 500 stocks in these funds are Microsoft Corp., Alphabet Inc., Apple Inc., Visa Inc. (V), and Cisco Systems Inc. (CSCO). Visa is the 5th largest holding of the iShares ETF, and the 9th largest of the Vanguard ETF. Meanwhile, NextEra Energy Inc. (NEE), the largest operator of wind and solar electric generation facilities in the world, did not make RBC's list.
The reason for this unexpected result is that leading tech companies often receive high ratings across multiple ESG criteria. Microsoft, for example, received the top rating of AAA from index provider MSCI for its adherence to ESG principles, putting it in the top 4% of software and services companies. MSCI gave Microsoft high marks on privacy and data security, corporate governance, lack of corruption and instability, and clean-tech-innovation capacity.
Meanwhile, both Amazon.com and Facebook Inc. (FB), another popular holding among ESG funds (and the 5th largest holding of the Vanguard ETF), have some poor ratings counterbalanced by some good ratings on other criteria. Amazon.com got bad reviews from MSCI on labor management, while Facebook received poor marks on data security and also privacy.
ESG-driven investing is likely to gain in popularity as institutional investors become the driving force, according to recent report from KPMG. Nonetheless, as Todd Rosenbluth, head of ETF and mutual fund research at investment research firm CFRA cautions, "What's considered a good ESG stock is in the eyes of the index provider."