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Institution / Investment managers

Quality vs quantity: the (very) mixed bag of ESG ETFs in the market

The number of ESG ETF launches shows no signs of abating, and while many are now aligning with the UN SDGs, their diversity and quality are questionable.

ETF SDGs
Despite SDG 13 being the Sustainable Development Goal asset managers are most likely to be aligned with, the quality of exchange-traded funds is almost pot luck. (Photo by Mirko Graul via Shutterstock)
  • New data reveals ESG ETFs are on the rise, and starting to align with UN Sustainable Development Goals.
  • Capital Monitor analysis reveals that low sustainability-grade ETFs are rising at a rate equivalent to those with a higher sustainability grade.
  • Roughly a quarter of ESG ETFs rate no better in terms of sustainability than their non-ESG branded equivalents.

The growth of ESG-themed exchange-traded funds (ETFs) has been dramatic. Between 2019 and 2020, the number of new funds being launched increased by a striking 223%, according to TrackInsight, a data provider.

The asset management sector kicked off this year with the same level of enthusiasm. In the first quarter, another 87 ESG ETFs came to market. The number now stands at 758, with assets under management (AUM) totalling $264bn.

Furthermore, new data from TrackInsight reveals that ETFs are starting to align themselves with the UN Sustainable Development Goals (SDGs); 15 of the 17 SDGs are now covered in some way by a fund.

However, the distribution of ETFs across the various SDGs is far from equal. Perhaps unsurprisingly, SDG 13 – Climate Action – is a key focus among asset managers to date.

Quantity, not quality 

While BlackRock’s iShares, UBS, Amundi, DWS and Invesco account for 65% of all ESG ETF AUM, Capital Monitor analysis reveals that quantity does not always equate to quality when it comes to sustainability ratings.

Focusing on 388 ESG ETFs with the highest and lowest sustainability scores, we discovered ETFs with an ESG rating of C or D are growing at a similar rate to those with high grades. More recent data indicates that the rate of growth of high-quality ETFs is starting to overtake those of a lower standard. However, the present gap should be a worry for any discerning investor.

iShares, for example, has 36 ESG ETFs that have been awarded A grades (A+, A, A-) for sustainability, but has also launched 39 with C grades or below (C+, C, C-, D), according to TrackInsight.

To put this into context, TrackInsight shows that just over three in four (78%) ESG-branded ETFs in the marketplace contain a portfolio of assets that rates higher that their non-ESG equivalents, while 15.4% of ESG ETFs rank the same, and 6% actually rank worse. In short, almost one in four ESG ETFs in the market are no better than their non-branded peers.

So, how are the grades calculated and what do they mean?

TrackInsight uses a consensus-based ESG scoring system, designed by its partner Conser, a Swiss-based independent ESG verifier. As part of its scoring methodology, Conser assesses data collected across different sources, the consensus strength across each source, and the portfolio impact.

It first screens all companies in a portfolio, identifies its assets, and then constructs an ESG consensus by weighting the aggregate of the individual ESG consensus of issuers in the portfolio, and measures the average and strength of those consensuses.

Conser will then screen all issuers in the portfolio to identify sector exposure, breach of international norms, and climate impact, before aggregating the ESG quality and strength of its underlying assets at a portfolio level and assigning each an A+ to D grade. It also applies a “red flag” to portfolios that have a 1% or higher exposure to a “sensitive sector”, such as gambling, tobacco or weapons.

As Capital Monitor recently reported, the proliferation of ESG indices poses a dilemma for investors, as the methodologies of ESG ratings are proprietary and lack transparency. The findings above only add to the concern that ratings are potentially masking underlying issues with the stock selection process.

According to TrackInsight, “many investors might be surprised to find out that not all ESG ETFs have good ESG scores – and, vice versa, some non-ESG ETFs have excellent ESG scores”.

To be, or not to be SDG

Taking it a step further, Capital Monitor analysed all ETFs explicitly aligned with an SDG and found the ESG ratings of each of these ETFs are, on average, little higher than across non-SDG-aligned ESG ETFs.

A closer look at some SDG-aligned ETFs that have low ESG grades provides an indication of what industries they focus on alongside the SDGs, and the findings cast some doubt as to whether being SDG-aligned bears much weight.

For example, one ESG ETF, which is listed as being aligned with SDG 9 (Industry, Innovation and Infrastructure), was launched in 2018 by Amplify ETFs and is red-flagged as having a major “environment” controversy, indicating that it has at least 1% exposure to an environment risk.

Its portfolio is listed as including chemicals company LG Chem and commodity trading and mining company Glencore, and the ETF has a significant 8.75% exposure to BHP Billiton, one of the world’s largest miners. However, it is not clear whether its low rating is due to its exposure to these companies.

Another ESG fund that is aligned with SDG 13 (Climate Action), but is rated with a D grade for sustainability, was launched by Ossiam in 2019. It is flagged as being involved in three “major controversies” under the categories of weapons, the environment and human rights. Its three biggest exposures are to ExxonMobil, Chevron and ConocoPhillips, which are some of the worst largest polluters.

Multiple ESG products vs responsible investment rankings 

One suggestion offered by TrackInsight about how to distinguish between the wealth of ESG ETFs in the marketplace is to assess how far the ETF providers’ “business practices and philosophy align with your ideas of ESG”.

And while this recommendation implies that, even with quantifiable rankings, the ESG credentials of funds and their providers are partially subjective, there are external rankings of asset managers’ commitments to socially responsible investment.

For example, ShareAction, a charity that holds investors to account for their sustainability commitments, has ranked the world’s 75 largest asset managers across responsible investment themes, including governance, climate change, human rights and biodiversity.

Out of 75 asset managers included in the survey, the top five providers of ESG ETFs are ranked as follows: 47th (BlackRock), 33rd (UBS), 15th (Amundi), 19th (DWS) and 46th (Invesco), revealing a lack of correlation between the number of ESG products launched by a provider and its stewardship practices.

Voting records is one metric ShareAction uses to assess investors, although as it only captures voting data from 2019, it’s possible that some of these investors have taken steps to engage more actively with the companies in their portfolios.

Polly Bindman

Data Journalist

Polly joins the team as our data journalism lead tasked with making sense of the world via data and infographics.