Spot the difference. Does ESG matter in ETFs?

A theme that has been bounced around for the better part of two decades is getting its day in the sun. This year's Inside ETFs Australia conference, hosted at the ASX yesterday, asked the question: is ESG just a marketing fad or is there something more meaningful for investors? 

So, purely from a global inflows perspective, ESG is an undeniably powerful theme. And one of the much-favoured ways to tap into ESG is through ETFs. 

By 2030, there will be an eightfold increase in ESG investing globally, said Meaghan Victor, head of SPDR ETFs APAC for State Street Global Advisors. 

BlackRock is predicting this figure will hit US$1.3 trillion by 2029. 

"If we look at the flows for iShares globally, 22% is ESG sustainable investing, this year," said Steve Ead, head of iShares product, BlackRock Australia.

"So that's a large shift of investors looking for ESG portfolios and we see these number getting bigger and bigger. As we look at ETFs and index funds together globally, we're looking at around US$430 billion in assets (currently)." 

Inside ETFs Australia conference. Source: Livewire Markets. 

ETFs are often associated with the millennial and Gen-Z investor crowd because of the simplicity of the structure, ease of access and high liquidity. But ETFs suit a range of investors. 

The ASX's Australian Investor Study 2020, showed that 25% of "High Value Investors" hold ETFs. That is defined as "the top 20% of investors by both wealth and trading value ... typically over 55 and male, with 43% aged 60 or over."

Moving away from the E in ESG: What's on the tin? 

So, why is there a lingering question about marketing gimmicks in ESG ETFs? Well, in part this has to do with our understanding of ESG. For a long time, it was always about the environmental sustainability of a company and its products. 

According to Victor, the "S" and the "G" in ESG do a lot of the heavy lifting. This is perhaps why, as you look across a lot of ESG-branded ETFs there's not a lot of companies you'd immediately recognise as environmentally sustainable. 

"We have had a focus on ESG due to climate ... There's now been a greater focus on the "S" and the "G" also. So this is not just something for the millennials, but it is very much for the broader investment universe to consider in terms of portfolio construction," said Victor. 

An alternative to broad-based ESG ETFs is to tap into an ESG-thematic through an ETF, such as an electric vehicle ETF or clean energy ETF, which picks a basket of stocks around a theme.

But BlackRock believes ESG will be the foundation of all future portfolios. In fact, Ead argues that investors are better off sticking to a broad-themed ETF than a thematic ETF.

"The broad-based ESG ETF is really trying to give you broad market exposure," he said.

"When you are in a thematic ETF you really are honing down on a particular thing. So you're reducing the breadth. You're really looking at one particular type of change," he said. 

It's a tough nut to crack and we, the audience, get no real satisfaction as to whether ESG is a marketing gimmick, although the evidence certainly suggests that it's here to stay. 

When Ead is asked why people think ESG is a marketing gimmick his answer is "I'm not sure." 

Let me put forward the suggestion that perhaps it's considered a gimmick because much of the holdings across ETFs are similar regardless of putting an ESG screen over it. 

Take, for example, this table from an earlier session presented by Stockspot. As you can see the top holdings from fund to fund are marginally different. 

Spot the difference between ESG and non-ESG holdings. Slide from an earlier presentation using data from Stockspot, Morningstar as at 30 April 2021. Source: Livewire Markets. 

Does it matter? 

Well. That's subjective. It really depends on why you want to invest in an ESG fund. Arguably, the best companies in the world are moving towards better governance, more social awareness and environmental responsibility. Victor argues there are very few companies on the ASX200 which don't adhere to ESG principles. Only about 15 companies haven't participated at all in some form of ESG process. 

What investors really want to avoid is exposure to stranded assets - major holdings in sunset industries that are on a downward trend to nowhere.

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