It seems everything is coming up ESG these days except, of course, ETFs.
Investing strategies that incorporate environmental, social and governance factors or ratings approached $12 trillion for U.S.-domiciled assets at the end of 2017, according to recent data by the U.S. SIF Foundation. Of the nearly $4 trillion in ESG or related strategies controlled by asset managers across equity, fixed income, cash, commodities and real estate, 92% was managed in an active strategy. And, of the 8% indexed assets, only $7.3 billion was held in passive exchange-traded funds, despite a significant expansion in ESG-linked ETF offerings.
By comparison, according to the Investment Company Institute, passive or indexed-strategies in mutual funds totaled almost $7 trillion in aggregate at the end of 2017, with almost half held by ETFs.
Whether ESG investing adds alpha is a source of endless debate and countless academic studies, but mission- and purpose-driven institutional investors, including some that are motivated by politics or religion, increasingly are aligned with the Principles for Responsible Investing and the United Nations' Sustainable Development Goals. And BlackRock Inc., the world's largest money manager and ETF issuer, is on trend.
In January, CEO Laurence D. Fink crowed about "a sense of purpose" and ESG in his January letter to other CEOs. "A company's ability to manage environmental, social and governance matters demonstrates the leadership and good governance that is so essential to sustainable growth, which is why we are increasingly integrating these issues into our investment process," Mr. Fink wrote.
Now BlackRock is testing the theory in ETFs by pressing its ESG-related offerings into a separately marketed suite centering on a "sustainable core."
Announced last month, the core offerings track equity indexes from MSCI Inc. and bond indexes from Bloomberg LP. The iShares issuer also launched model ETF portfolios for use by financial advisers and retail investors.
While BlackRock manages the only billion-dollar ESG ETF on the market, the $1.17 billion iShares MSCI KLD 400 Social Index, Eric Balchunas, Bloomberg senior ETF analyst, has been watching the assets and trading of two broad-market ESG ETFs launched in September by Vanguard Group Inc.
"For years, ESG was one of the few areas of the ETF market that had yet to succumb to the Vanguard effect," said Mr. Balchunas, describing the across-the-board reduction in expense ratios that often follows the company's entrance into a new market, category or asset class. He has observed that the lion's share of fund flows go to ETFs with expense ratios below 20 basis points.
At 12 basis points, the $26 million Vanguard ESG US Stock ETF tracks a FTSE U.S. all-cap index composed of nearly 1,000 companies, excluding fossil fuel and nuclear power producers, weapons and firearms manufacturers, alcohol and tobacco manufacturers, among others, and companies involved in conflicts related to diversity, human rights and environmental violations. BlackRock covers similar exposures through two products tracking MSCI indexes and charges 15 and 17 basis points, respectively, for the multicap and small-cap ETF.
"ESG considerations dip into what people view as right or wrong and concepts of morality," Mr. Balchunas said. "It belies some of the objectivity inherent to a core belief of many indexers — own the market."
According to research firm XTF Inc., ESG ETFs held $7.3 billion as of Nov. 1, attracting $1.73 billion in net new money year-to-date. Fund options range from narrower, thematic offerings promoting gender diversity, clean technology and water resources to index funds trying to rebuild the risk characteristics of the broader market, despite exclusions and reweighting to ESG factors.
And despite issuers' best efforts to build an ESG niche in ETFs, it's possible that asset growth might never come to these specific products. Instead, institutional investors like Japan's ¥158.6 trillion ($1.42 trillion) Government Pension Investment Fund and Sweden's 366.9 billion Swedish kronor ($40 billion) AP4 (Sweden) have made ESG core to their entire investment process.
Asset managers, including BlackRock, Vanguard and State Street Global Advisors, also are raising issues of sustainability, climate change and diversity broadly across their proxy voting and engagement activity, effectively co-opting the message of their smaller, less liquid, more concentrated ETF offerings.
"This indirect integration is already happening," said Aniket Shah, head of sustainable investing at OppenheimerFunds, New York. "And companies are responding and improving along these metrics. But what will really move the needle is the financial industry perspective, particularly from sell-side analysts."
