By Shaheen Contractor, ESG Analyst, Bloomberg Intelligence.
Cleaning up ETF ESG Greenwashing
ESG ETF assets hit $218 billion last year as the number of funds grew and asset managers launched new funds to capitalize on the growth in the market.
However, even though environmental, social and governance (ESG) factors have become a major influence in the market, it is still difficult for investors to understand what exactly ESG ETFs offer.
ESG means different things to different companies which is challenging for investors. The many varying definitions, and the drastically different strategies for how funds integrate their holdings, create a Wild West.
The lack of a cohesive definition exposes investors to widespread concerns of exaggerating or misrepresenting a fund’s benefits to attract business. The effect, known as greenwashing, is coming under increasing investor and regulatory scrutiny. The Global ESG High Quality Growth Equity Fund, for example, recently triggered a regulatory review into fund labels to protect investors from possible greenwashing.
To help investors make selection decisions and compare environmental, social and governance characteristics across ETFs, Bloomberg Intelligence launched its ESG ETF Exposure Scorecard. BlackRock’s iShares ESG MSCI USA Leaders ETF and iShares MSCI EM SRI ETF as well as the BNP Paribas Easy MSCI EMU SRI S-Series 5% Capped ETF and are among those indicating high levels of ESG exposure.
Our scorecard rolls up key metrics across each of the ESG pillars for the fund in question. These E,S, and G metrics chosen are portfolio weighted and aggregated at a fund level to ensure all scores are relative across funds. This results in an overall score of one to 10, with 10 being the best. The funds that trail with lower scores exhibit varying characteristics, such as a small-cap bias. This is because small-cap companies usually trail large-cap peers on both performance and disclosures and hence such funds may trail regional benchmarks and peers owing to strategy divergences. Funds that lag regional peers after accounting for such divergences warrant analysis depending on an investor’s goals.
Europe leads on the environmental pillar
ESG ETF exposures vary widely by region (our analysis covers large ESG ETFs allocated to the US, Europe, and emerging markets, totalling around 31 funds) and our analysis summarizes some of the more stark regional trends across our ESG pillars. Driven by better corporate disclosures and performance in Europe, funds allocated to the region have the greatest degree of ESG intensity as indicated by a median score of 7.16, signifying greater amounts of ESG integration compared to the US (6.86) and emerging markets (1.63).
Companies in emerging markets are far behind developed market peers on ESG and are trailing behind as a result. Emerging markets funds also seem to offer the lowest incremental exposures as measured by the median fund rank versus its regional benchmark.
Our universe includes some of the largest funds that use an ESG strategy and represent close to 35% of assets held in global equity ESG and values-based strategies as of 2020.
ESG funds allocated to European companies lead our scorecard on the environmental pillar with funds scoring a median 7.64, higher than other regional benchmarks. Europe is at the epicentre of climate regulations and disclosure guidelines, meaning funds that better integrate ESG might have a competitive advantage.
Credit Suisse‘s CSIF IE MSCI USA ESG Leaders Blue UCITS ETF, the BNP Paribas Easy MSCI EMU SRI S-Series 5% Capped UCITS ETF, and the iShares ESG Aware MSCI EM ETF lead their regions on the environmental pillar.
Our pillar balances both disclosures and performance to capture the broadest universe possible. It includes the CDP Integrated Performance Score, the carbon intensity of funds, and Bloomberg’s Environmental Disclosure Scores.
Social is harder to quantify but the US leads on governance
Similar to the environmental pillar, ESG funds allocated to Europe lead our ranking on the social pillar with a median 7.06 score, although the US seems to offer the highest amounts of incremental exposures.
Understanding social exposures can be hard to measure due to poor coverage of such metrics and the lack of comparability. Our social pillar includes Bloomberg’s Social Disclosure Scores and the proportion of female executives as a proxy for performance.
ESG funds allocated to the US lead our ranking on the governance pillar, suggesting better oversight and risk management. The pillar is composed of Bloomberg’s board composition scores where US companies score better compared to other regions.
The greatest incremental exposures are in Europe, where the median is 0.62 points higher than the regional benchmark. Emerging market funds are no better than their benchmark, indicating the lack of benefits from improved board composition in regions that stand to benefit from this the most.
The Amundi MSCI Emerging ESG Universal Select ETF is among the few funds performing substantially better than the benchmark.
Other pillars of the governance score like executive pay will be included in the scorecard as they are released. While the US leads on board composition, it might score poorly on executive pay which could ultimately change the rankings.
ESG can help attract institutional investment
Though Europe has been a traditional leader in ESG ETFs, North America could keep narrowing the gap as its share of total assets increased to 34% in 2020, up from 20% in 2016. ESG is a way to attract institutional capital to ETFs in spite of such investors typically shying away from ETFs except for a few highly liquid ones.
The iShares ESG MSCI Mexico ETF has attracted more than $600 million in capital, much of which is from institutions. Competition and fee pressures have intensified across regions, and smaller, expensive ETFs risk getting crowded out unless they outperform and see adequate demand. At least 13 ETFs liquidated in 2020.
The small nature of funds, high levels of consolidation, and an overcrowded US market will add to liquidation pressures.
The developing ESG ETF Market
The market for ESG ETFs is fairly consolidated, suggesting increased competition among asset managers. Low fees are a large driver for inflows with the push to reduce them putting pressure on smaller companies.
BlackRock, UBS, Amundi, and DWS accounted for 75% of net inflows in 2020. BlackRock alone accounted for more than half, reflecting its offering of the largest number of funds.
As competition increases, asset managers with relatively low expense ratios such as Vanguard, DWS, and Credit Suisse stand to benefit. Invesco has a high median asset-weighted expense ratio, as a number of funds offer clean-energy themes that tend to have higher fees.
A low-carbon screen is fast becoming the norm for ESG funds. This boosted flows to climate ETFs which could continue to see support from favourable policies like the European Green Deal. Clean energy fund flows rose 13 times last year against 2019, and low-carbon or fossil-free funds five times.
Rising flows to clean energy reflect recent performance, though high volatility and fees make such interest cyclical. During the downturn, clean energy ETFs had big declines in performance and flows.
Similar to clean energy, we find that complex ESG themes like diversity and inclusion are often more expensive. Such funds risk liquidation unless returns justify costs. Funds can have multiple ESG approaches with flows being counted for each. Many combine bans on certain assets with other strategies, boosting the exclusionary category.
(The views expressed here are those of the author and do not necessarily reflect those of ETF Strategy.)