Long the domain of politically minded pension funds and mission-driven foundations, investing with a keen eye on climate risk is pushing through to the mainstream, bringing with it yet another series of decisions for exchange-traded fund investors to muddle through.
For years, ETFs focusing on environmental, social, and governance factors have been a backwater of the $4.5 trillion U.S. ETF market. But asset growth has been swift over the past year — more than $8 billion in net flows to top $22 billion in assets under management, according to research from XTF Inc. The bulk went to MSCI-indexed products from BlackRock Inc., while Vanguard Group attracted more than $1.2 billion to two FTSE-based index products launched in September 2018.
"Previously, many products were not that interesting to us, as they could have so many ESG layers that they were no longer tracking a more mainstream index and pricing was not competitive," said Anna Hyrske, head of responsible investments at Ilmarinen Mutual Pension Insurance Co. in Helsinki. "Now we see passive products following mainstream ESG indices with very competitive pricing."
At the end of the third quarter, €49.1 billion ($54.6 billion) Ilmarinen held roughly $2.6 billion in two products from BlackRock and DWS Group, both tracking the MSCI USA ESG Leaders index.
Yet as the burgeoning market struggles to define itself in the face of investor demand, the Securities and Exchange Commission is reportedly bearing down for clarity in marketing. In a speech before the American Enterprise Institute last June, SEC Commissioner Hester Peirce channeled her namesake and delivered a diatribe against those "scarlet letters" — E, S and G.
"Popular discourse has fueled the efforts of ESG instigators, which include developers of ESG scorecards, proxy advisers, investment advisers, shareholder proponents, non-investor activists and governmental organizations," she said. Ms. Peirce went on to argue that much of the material going into ESG ratings, and therefore ESG-linked indexes, come from company surveys and voluntary reports.
Todd Rosenbluth, senior director of mutual and exchange-traded fund research at CFRA Research in New York, sees such hand-wringing on ESG ratings as simply being an extension of the indexing discussion. "We have different index providers determining what are growth or value stocks based on distinct definitions," he said. "ESG is based on data and the analysis of that data. The fact that S&P and MSCI don't have the same view on the ESG ratings of companies is not that different."