Many investors are hearing about the exponential rise of smart beta funds, a growing group fundamentally-weighted exchange traded funds (ETFs) that are outpacing the already impressive group of the broader ETF space.
As the smart beta universe expands, issuers are searching for new ways to attract investment dollars. While the idea of investing with a moral purpose is not new, it is seen as viable growth opportunity in the index fund universe. Funds that adhere to environmental, social and governance (ESG) principles are growing in population with many market observers projecting asset growth to follow in the years ahead.
Some ESG ETFs, also known as sustainable funds, have lengthy track records. For example, the iShares MSCI USA ESG Select ETF (SUSA) is fast approaching its 13th birthday while the iShares MSCI KLD 400 Social ETF (DSI) recently turned 11 years old. However, many of the approximately 50 ESG ETFs trading in the U.S. lack three-year track records, let alone the five- or 10-year records many investors look for.
Slicing and Dicing Impact Investing
The idea of impact investing is fluid and fund issuers and index providers treat it as such. That is to say, when an investor evaluates multiple ESG ETFs, she should not expect a lot of identical twins in the lot.
For example, the aforementioned DSI, the largest US-listed ESG ETF, tracks the MSCI KLD 400 Social Index. That index has been around since 1990 and takes a prosaic approach to impact investing. The benchmark includes companies involved in gambling, pornography, tobacco, production of weapons and nuclear power. That is standard fare among many socially responsible investing (SRI) instruments.
The newer generation of ESG funds offers investors more refined approaches. As one example, the Global X Catholic Values ETF (CATH) holds S&P 500 member firms that are deemed acceptable by the United States Conference of Catholic Bishops (USCCB). A lot of the S&P 500 fits that bill because CATH holds 462 stocks.
Then there are ESG funds that really emphasize the “E” in ESG. For example, the iShares MSCI ACWI Low Carbon Target ETF (CRBN) is a global, broad market collection of over 1,200 companies that have lower carbon footprints compared to traditional equity benchmarks.
Another popular approach in the impact investing universe is focusing on diversity. Home to nearly 170 stocks, the SPDR SSGA Gender Diversity Index ETF (SHE) “seeks to provide exposure to US companies that demonstrate greater gender diversity within senior leadership than other firms in their sector.”
Data suggest there is growing enthusiasm for ESG products. In its recent ETF industry survey, Brown Brothers Harriman “found greater interest in Environmental, Social and Governance (ESG) ETFs, with 51% of investors finding ESG at least somewhat important vs. 37% last year.”
ESG in Fixed Income
As smart beta has evolved and become more widely accepted, advisors and investors have wondered when that trend will permeate the fixed income space in earnest. The number of smart beta bond ETFs is small, but growing. The same is true ESG bond funds.
Only a handful of existing bond ETFs can be considered ESG or SRI funds, but the concepts backing these products are unique. The VanEck Vectors Green Bond ETF (GRNB) debuted in March and has $10.7 million in assets under management. Green bonds are issued by companies and governments to raise funds for what are deemed to be environmentally friendly projects.
iShares has a suite of ESG-based bond funds, including the iShares ESG USD Corporate Bond ETF (SUSC). That ETF's index methodology is familiar as tobacco companies are excluded as are weapons. Any company with one or more “severe” ESG controversies are also excluded.
There is a significant growth opportunity for ESG funds and that growth is underway as combined assets under management for these, including ETFs and mutual funds, more than doubled from 2012 to 2016.