Sustainability challenges in ETFs

In a recent Funds Europe roundtable, ETF experts discussed challenges faced by issuers when launching sustainability-focused ETFs.

Raymond Backreedy, chief investment officer of Sparrows Capital, said that many customers asked for ESG – or environmental, social and governance – portfolios. 

“The first thing one needs to do is understand exactly what they want,” he said. “We need to take a step back and look at the index providers and what kind of ratings they are using, the ratings agencies and how they are constructing the indices, and then in turn how the ETF is constructed.”

Backreedy highlighted that, regarding the UN’s Sustainable Development Goals, most indices and ETFs across those indices are aligned to climate change and carbon-offsetting over anything else. 

“There are a lot of ETFs tracking climate change/environmental flavours, but there is a lack of ETFs in areas such as social justice,” he said. This is down to issues with data and metrics, he added, pointing out that it is difficult to capture all 17 SDGs, especially when some are hard to quantify.

Marie Dzanis, head of asset management for Emea Northern Trust Asset Management and chief executive officer for Northern Trust Global Investments, said this presents an opportunity.

“Data shows that less than 30% of global ESG-focused issues align with SDGs. When you look at it further, 90% of exclusion-only ETFs don’t align to SDGs at all,” she said.

“This is due to their narrow scope because there is a lack of structured data and standards for measuring. There’s also subjectivity in financial return measurement, and increased focus on specific angles, like climate and carbon, that leaves many of the SDGs underrepresented. Some is scooped up into impact investing.”

This could be a challenge when looking at the lack of breadth of public investments directly into companies that could align with SDGs.

“For example, in the US when we were creating products years ago, having a water ETF looking at the upstream or downstream consequences and what would be in that would dilute the actual outcome or the exposure to a water security,” said Dzanis.

According to Jason Guthrie, head of capital markets and digital assets at ETF provider WisdomTree, what muddies the water even further is a lack of consensus from clients. 

“It’s a very nuanced space and you could take a lot of very nuanced approaches. Even when we’re just talking about exclusion lists and the like, where do you draw the line on what this is meant to be? There are some very strict approaches to sustainability, and there are some very lax ones,” he told panellists

“This plays out even more acutely when we get to the ‘G’ of ESG – governance – when it comes to voting on stocks, on board governance etc, this becomes very subjective, and it becomes difficult for some people to balance the social outcomes with the investing outcomes, because at the end of the day, that’s what we’re here for.”

BlackRock’s head of products for iShares Emea, Benoit Sorel, pointed out that although “everyone agrees with the UN’s Sustainable Development Goals”, from an investment perspective they are narrow in what they can achieve.

“There are only a handful of investable SDGs, such as good health and wellbeing (SDG3), clean water and sanitation (SDG6) or sustainable cities and communities (SDG11). Each of these represents a narrow prism of thematic investing,” he said.

“The reason why we have collectively gathered so many assets in sustainable strategies last year is because they come as a replacement for core holdings, both equity and fixed income. Broad sustainable indices allow investors to implement their sustainable strategies with a financial outcome in line with their historical allocation tools.”

Meanwhile, Keshava Shastry, head of the Efama task force and head of capital markets at DWS, highlighted that sustainable investing is still a relatively young practice.

“Rapid growth and progress is being seen at the global and European levels, but work needs to be done on implementing the framework and taxonomies to align the wide-ranging issues within the space. ESG is one of the many measures of sustainability, but there are plenty of different ways about it,” he said. 

“While there is a significant overlap between the various metrics, products targeting the various gauges such as climate and other various angles are still being left out. Ultimately, we’re there to provide a financial instrument for people’s long-term goals, and long-term depends on how you define it.”

Read the full report here: ETF roundtable: Seeking harmony in Europe



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