By Debbie Carlson
Environmental, social and governance investing resonates with people who want their investments to align with their values, and the boom in this investing style has fund companies launching more ESG investment vehicles.
But these funds may not be as green as investors think they are.
ESG investing considers both financial return and social and environmental good. But just as investors can disagree on where to draw the line between value and growth investment styles, they can come to different conclusions about how well companies are delivering in these areas. There are no U.S. nor global standards.
As a result, ESG investing comes in different shades of green. Traditionally, ESG investing was done by active managers at fund firms with decades of conducting their own research in sustainability, gathering data and creating deep investment processes. They press companies to become more sustainable and seek better corporate behavior. These early adopters are among the deepest green of ESG portfolio managers.
The rise of passive-index ESG investing, however, has added more green variations. With these funds, the asset managers set their ESG goals and work with an index provider to create the strategy. The outside firm does the analysis and creates the rules-based methodology; the fund family licenses the index.
Regardless of the strategy, the fund manager still decides how hard to push companies on ESG goals. He or she may or may not vote in favor of ESG measures or advocate for sustainability. Fund families operating the lightest of the light-green funds incorporate ESG factors on a limited basis and aren’t activists.
There is some debate among industry insiders whether light-green, also known as “light-touch,” ESG funds are more about marketing than sustainability. Using ESG data in a limited way isn’t “greenwashing” — saying something is sustainable when it’s not — since asset managers post each fund’s goal and ESG criteria on websites and go deeper in prospectuses. But not every investor takes time to read those prospectuses. And it takes time to read up about an asset manager’s shareholder advocacy.
A fund’s shade of green matters if an investor thinks their ESG fund has a strict strategy to affect change and the management purses those goals. Others may be fine that their fund is just limited to a portfolio of high ESG-rated companies. Either way, investors need to look beyond the fund name to understand how the mutual fund or ETF approaches ESG; the broader investment style now accounts for one-third of U.S. assets under professional money management.
To begin determining if an ESG fund is a light-touch fund, look at its investment criteria. Sometimes ESG funds that also want to mimic broader stock-market index returns have to balance between owning the higher-ranked ESG stocks in a particular industry and choosing some names that might surprise socially conscious investors, says Todd Rosenbluth, director of ETF research at CFRA.
He used one of the biggest ESG ETFs by assets under management as an example: the $12.9 billion iShares ESG Aware MSCI USA ETF /zigman2/quotes/208081415/composite ESGU -0.42% , which chooses companies with strong ESG traits while still looking like a traditional market index.
While the ETF screens out controversial weapons, tobacco, shale energy and fossil-fuel reserves, it has 5.5% of its assets are fossil-fuel producers or consumers, including Exxon Mobil /zigman2/quotes/204455864/composite XOM -2.49% , Chevron /zigman2/quotes/205871374/composite CVX -2.30% and Exelon /zigman2/quotes/205982254/composite EXC -0.82% , according to a screen from As You Sow, which rates ESG mutual funds and ETFs.
“By being sector-neutral, you are going to have energy and you are going to have utilities, two sectors less-likely to be environmentally friendly. They may or may not be environmentally friendly, but they have strong governance or social characteristics,” he says.
Asked to respond, iShares media relations referred to a quote in a news release describing its suite of various ESG ETFs . “Sustainable investing was historically a values-based exercise –it has evolved into an investment risk and performance-based decision…. Our product framework delivers clarity and options for clients to help achieve their investment objective(s),” says Armando Senra, head of iShares Americas.
Another broad-based ESG ETF, the SPDR S&P 500 Fossil Fuel Free Reserves Free ETF /zigman2/quotes/209878707/composite SPYX -0.24% , has 5.3% of its $839 million in fossil-fuel producers or consumers, including a small holding in FirstEnergy /zigman2/quotes/201870541/composite FE -1.10% , a coal producer.
Matt Bartolini, head of SPDR Americas Research, says the SPDR suite of fossil-fuel-free funds is a rules-based approach to divest from companies with proven fossil-fuel reserves in high carbon-producing industries. It tries to balances an investor’s environmental interest with a financial return similar to broad-based benchmarks.
“Eliminating all firms that interact with carbon would result in a heavily concentrated portfolio that may not be suitable for all investors. As a result, there is a small exposure to firms that may interact with carbon, but do not have proven reserves – consistent with the intended investment strategy to only divest from firms with fossil-fuel reserves,” he says.