- Analysis of ESG ETF holdings finds strong similarities across funds with different ESG scores, raising questions as to the value these ratings offer.
- There’s a strong tech giant presence in many funds. Companies such as Alphabet and Microsoft are regularly found within the top ten holdings.
- Lower-rated funds have a slight bias towards “unfavourable” sovereign nations.
The growth of exchange-traded funds (ETFs) labelled as environmentally friendly , or ‘ESG’, has been striking. Between 2019 and 2020, the number of new ESG-labelled ETFs that came onto the market increased by 223%, according to specialist data provider Trackinsight.
And while supply is high, so is demand. According to research and consultancy firm ETFGI, net inflows into ESG ETFs and exchange-traded products listed globally reached $12.27bn in April, bringing net inflows to $67.72bn for 2021, three times higher than a year ago.
Yet while this growth is a clear sign investors are pursuing ESG strategies through passive investing, as Capital Monitor reported in May, quantity does not always equal quality.
By examining ratings from Conser, a Swiss-based independent ESG verifier that uses a consensus-based ratings approach, Capital Monitor found that ETFs with an ESG rating of C or D are growing at a similar rate to those with A grades, and that the ESG ratings of ETFs explicitly aligned with the UN Sustainable Development Goals (SDGs) are, on average, little higher than across non SDG-aligned ESG ETFs.
Lack of ESG diversity
This poses a problem for investors hoping that they are choosing a sustainable product when choosing an ESG-labelled fund. Capital Monitor finds that while ESG ratings vary across funds, the holdings of those funds are very similar regardless.
Taking a sample of three ETFs in the top 20 by net new assets in April (based on data compiled by ETFGI), we found striking similarities between funds awarded different ESG grades.
Furthermore, by analysing the top holdings of ten of these top 20 ETFs by net new assets, whose assets under management (AUM) total $17bn, we found a strong bias towards the information technology sector, with tech giants like Microsoft and Google’s parent firm Alphabet frequently listed in the top ten holdings of ESG ETF portfolios.
Our observations match those of StoneX, an investment platform, which itself recently conducted an analysis of ESG ETFs. It found that aggregating the holdings of the largest funds into a generic ‘ESG ETF composite portfolio’, reveals what Vincent Deluard, director of global macro strategy at StoneX, describes as a "clear bias towards the technology and healthcare sectors, which benefited from the global pandemic".
Developed vs emerging market exposure
In order to assess the differences between high and low-grade ESG ETFs – both equity and bond funds – Capital Monitor compared the holdings of ten ESG ETFs with the highest (A+) ratings, with a total AUM of $0.9bn, with 10 ESG ETFs with the lowest (D) ratings, with a total AUM of $1.3bn.
In these two samples there was a similar tilt towards both the tech sector and also sovereigns (via debt). An interesting distinction between the highest and lowest-graded ESG ETFs is that the issuers of the A+ ETFs only include European countries, whereas in the D grade ETFs, the range of government bonds is much broader, and includes countries like Brazil, Indonesia, Qatar, Saudi Arabia, Uruguay and Russia.
This could be because developed markets offer better access to ESG data than emerging markets, or that the latter has both lower standards for ESG reporting and a higher proportion of lower ESG-rated companies. It also corresponds with findings from Trackinsight, that ESG ETFs with exposure to emerging market equities have a higher risk of being exposed to controversies, such as including weapons or environmental concerns in their portfolios.
No standardised taxonomy
That the holdings ESG ETFs appear the same across ratings, where the main difference between higher and lower-rated ETFs is whether they’re more exposed to emerging or developing markets, places into question how much value an ESG label carries for investors.
This problem doesn’t look like being solved any time soon. In fact, according to Deborah Fuhr, founder of ETFGI, the distinct lack of taxonomy standardisation for ESG is a long-term concern. “We’re going to end up with a lot more fragmentation, with products that are compliant or industrious in different countries or regions,” she warns.