Supplements » ESG Report 2018

ETFS: Winning, not sinning

BettingThe number of sustainable ETFs has taken off in the past year or two but there’s still room for innovation, writes Romil Patel.

In 2017, new ETF launches outpaced their index funds counterparts for the first time in Europe. Part of the appetite for exchange-traded funds stems from their fees – which are substantially lower than those of actively managed funds – plus factors such as tax efficiency and transparency. There are, though, question marks around how ETFs would perform in a market downturn and whether they could even trigger a crash.

Sustainable investment is an increasingly important theme for asset managers and investors. Indeed, the latter group is becoming increasingly aware of the options available to apply environmental, social and governance (ESG) criteria in portfolio construction, without giving up risk-adjusted returns.

“There is an increasing awareness in the market now that people can go about accessing ESG-related funds through platforms and any other way they would typically buy funds,” says Andrew Walsh, head of passive and ETF specialist sales for UK and Ireland at UBS Asset Management.

“Before, the view was that to access an ESG portfolio, you would have to do this actively, but now there is a far greater awareness that there are passive solutions like ETFs that can deliver this in a transparent and cost-effective way.

“The key message is that ESG ETFs do not need to be a hindrance to your performance relative to a typical market cap-weighted exposure.”

At the end of 2017, there were almost 270 sustainable index mutual funds and ETFs worldwide, according to Morningstar. Collective assets under management (AuM) totalled almost $102 billion (€87 billion) – a threefold increase over five years.

ESG investing using ETFs provides investors with a rules-based, transparent mechanism for identifying companies that are prone to major controversies, and can subsequently help investors experience less portfolio volatility over time, notes Manuela Sperandeo, head of EMEA sustainable ETFs at BlackRock.

While passive funds are gathering momentum and a greater market share of sustainable funds, they are still a long way behind their vanilla counterparts.

“You will find on average all the ETFs from us and competitors are smaller than their non-ESG, standard equivalents and when we did a screen of the market, we did not find any ETFs that were above £1 billion (€1.1 billion) in AuM,” says Blanca Koenig, head of index investment specialists at DWS.

“That being said, we have seen a doubling in the number of ESG ETFs over the two years and equally assets have more than doubled over the same period, so there is definitely investment going into the category from client demand, but also providers are putting more emphasis on the matter, which is positive. We are coming from a very low base because the ESG trend is a recent phenomenon in the market.”

We are also seeing an evolution of the investor base, and the growing decision-making power of millennials and women in particular is driving ESG investment into the mainstream.

Greater granularity
The number of sustainable ETFs has been increasing – especially over the past 12 months. But there is still plenty of room for innovation, particularly as more investors look to build their ESG exposures. Sperandeo says: “We expect to see demand for greater granularity over time.”

As client demand for ESG ETFs increases and assets accelerate, asset managers have an opportunity to influence and change the way people invest – but only if they can successfully navigate the challenges.

“The definition of ESG is still a big challenge because you have the environmental, social and governance factors and within those there are very different ways of defining each one, so you can end up with very different understandings of what it means to investors,” says Koenig.

“Given ETFs are standardised instruments, it is then very tricky to find the biggest common denominator and to wrap that into an index and into an ETF strategy for clients.”

After a barren period for product launches, the range of diverse ESG ETFs is growing. Here, then, are some of the eye-catching ESG ETFs to hit the market in the past 18 months.

UBS
The Swiss giant is a leading provider of socially responsible [SRI] ETFs in Europe. The European Monetary Union SRI ETF (EMU) is at £591m AuM; the USA SRI product, £555 million; the World SRI, £544 million, the Japan SRI, £131 million; and the Emerging Markets SRI, £287 million. “These are all good-sized funds. It is not like one of them is a billion and the others are £30 million,” says Walsh.

Over the next 12 months, he anticipates more fixed income SRI and also more equity SRI-related exposure. “What we have now are real building blocks – we have got World, ACWI, Pacific, Japan, European Monetary Union, USA, UK, so we will continue to look at other geographic exposures and there is certainly scope there to expand the suite further.”

Earlier this year, the firm launched the UBS Global Gender Equality Ucits ETF, which has roughly $90 million in assets.

“That is a new thing for us because we are not using an MSCI index for that one, we are using a combination of Solactive, the German index provider, along with a company called Equileap Research [which applies a variety of ESG screens], so we continue to expand in this space generally for ESG-related ETFs and it is going to continue to be a big area of importance for us,” says Walsh.

DWS
This year, the asset management arm of Deutsche Bank announced the launch of a new range of ESG Xtrackers ETFs. They track indices that are part of the MSCI ESG Leaders Low Carbon ex Tobacco Involvement 5% series. Filtering is based on MSCI ESG research, meaning companies that are included fulfil certain ESG and low-carbon requirements.

The ESG ETFs are as follows:
     • Xtrackers ESG MSCI World Ucits ETF
     • Xtrackers ESG MSCI Japan Ucits ETF
     • Xtrackers ESG MSCI USA Ucits ETF
     • Xtrackers ESG MSCI Europe Ucits ETF

“We just launched our ESG equity ETFs, so they’re fairly small,” says Koenig. “The one that was taken up the quickest was the MSCI World, which is now £38 million in size. The others are still around £8 million – they are very small because they were just launched. The fixed income one we launched last year is a little larger at around $85 million in AuM.”

BlackRock
The gun debate is an emotive topic for many US citizens, particularly in the wake of the Florida high school massacre that claimed 17 lives in February. After the tragedy, students and activists across the US ratcheted up pressure on the Trump administration and the gun lobby for meaningful action.

Following the shooting, the world’s largest money manager said the event “requires response and action from a wide range of entities across both the public and private sectors”. BlackRock said it would launch two new ETFs excluding civilian firearm manufacturers and large gun retailers.

“We launched the iShares MSCI USA Small-Cap ESG Optimized ETF in April, and filed for an ESG AGG in April as well,” says Sperandeo. “We expect it will launch later this year.”

Amundi
With €1.4 trillion of managed assets, Europe’s largest asset manager announced the launch of a socially responsible US corporate bond ETF.

The Amundi Index US Corp SRI – Ucits ETF DR is designed to provide diversified US dollar corporate bond exposure while applying ESG selection filters. It seeks to replicate the performance of the Bloomberg Barclays MSCI US Corporate SRI Index.

The Amundi Index US Corp SRI – Ucits ETF DR has $260.6 million in AuM.

Amundi’s managing director, Fannie Wurtz, restated her belief that SRI will continue to expand and reiterated the firm’s commitment to “offering the relevant bond and equity tools adapted to these new requirements”.

Vanguard
Looking to make an entry into the ESG ETFs arena, Vanguard announced it had filed for two of these products with the Securities and Exchange Commission in June 2018. The firm manages $5 trillion of assets globally.

The Vanguard ESG US Stock ETF and Vanguard ESG International Stock ETF are expected to begin trading in September this year. The former will track the FTSE US All Cap Choice Index whilst the latter’s benchmark is the FTSE Global All Cap ex US Choice Index.

“The adoption of ESG investing has accelerated in recent years, and more investors are looking for opportunities to align their investment choices with their values,” said Jon Cleborne, head of Vanguard’s Portfolio Review Group. “Our new ETFs marry Vanguard’s characteristic low-cost, diversified investment approach with a rigorous ESG screening process.”

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