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Editor’s Letter: October 2018

Is a One-Size-Fits-All ESG Fund Possible?

Vanguard is introducing two new exchange traded funds based on environmental, social and governance criteria.

It’s welcome news to ESG advocates. Investors will have access to ESG funds for pennies, instead of dimes, and it adds credibility for ESG in the eyes of everyday investors.

But it also brings a greater urgency to a problem for advisors: Broad index-based ESG funds are not all the same; they vary wildly in the way they’re created and how they interpret the massive amount of ESG data out there. You usually won’t find those differences spelled out in the funds’ marketing literature; they’re usually described simply as “tracking the performance of companies with positive environmental, social and governance characteristics.”

But the criteria for measuring those characteristics varies depending on who is doing the analysis, and it doesn't always make intuitive sense. One of the largest ESG ETFs in the world, iShares MSCI KLD 400 Social ETF (DSI), with some $1.2 billion in assets, includes McDonald’s, ConocoPhillips and Occidental Petroleum—companies not always seen as benevolent contributors to environmental or social welfare.

The Wall Street Journal recently noted that index provider FTSE gives Warren Buffett’s Berkshire Hathaway the lowest ESG score of any member of the S&P 500, while MSCI puts it in the “average” bucket. Comcast is the other way around, scoring high on FTSE’s analysis but middling on MSCI’s. FTSE gives General Motors and Exxon Mobile a better ESG score than electric car manufacturer Tesla, because “it looks at the energy use within the company and its supply chain, not at its products,” according to the Journal.

The index that Vanguard will use for U.S. stocks is the FTSE USA All Cap Choice Index, which excludes companies involved in non-renewable energy (no nukes or fossil fuel burners), among other criteria. Yet, slightly over 2 percent of index holdings are oil and gas companies (much lower, to be sure, than the non-ESG version of the index, where they represent over 5 percent). An investor seeking to avoid oil and gas companies altogether may or may not find their values reflected here.

This is not a criticism of FTSE or Vanguard, simply an observation that there’s no consensus on what a “good” ESG portfolio looks like, and that makes the advisor’s job of matching the “right” fund to a client’s individual expectations and priorities a difficult one.

Most of these funds are sold on a premise that they align investor values with their investment dollars; some make the case they should lead to a fund that outperforms. It is concerning that there is so quickly a land grab for assets in ESG strategies before advisors and investors have better tools to understand just what it is they’re buying.


David Armstrong


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