Environmental, social and governance (ESG) ETFs experienced strong demand since the beginning of 2019, albeit off a low base, and have been a much- discussed topic within the asset management industry. In February, BlackRock highlighted that the $5 billion of 2019 net inflows into iShares US ESG ETFs more than doubled from the prior year, aided by $2 billion into iShares ESG MSCI USA Leaders ETF (SUSL). iShares also plans to launch a suite of fossil-fuel screened ETFs covering global equities.
Other asset managers that recently expanded their ESG lineups connected to established investment strategies include DWS and PIMCO. In June 2019, DWS rolled out Xtrackers S&P 500 ESG ETF (SNPE), which offers an ESG tilt to the most prominent U.S. equity benchmark tracked by SPDR S&P 500 ETF (SPY) and others. Meanwhile, PIMCO Enhanced Short Maturity Active ESG ETF (EMNT) provides ESG-focused investors an alternative to the largest actively managed fixed income ETF, the $15 billion PIMCO Enhanced Short Maturity Active ETF (MINT).
With the supply of ESG ETFs increasing in hopes of demand climbing further, we spoke to some institutional investors that manage money using ETFs for advisors and high-net-worth clients. We hoped to better understand how they navigate the broad range of ESG options and what they are hearing from clients. Eric Biegeleisen is managing director of research for Massachusetts-based 3 EDGE Asset Management; Kevin Harper is Chief Investment Officer of Pennsylvania-based Almanack Investment Partners; and Joe Mallen is Chief Investment Officer of California-based Helios Quantitative Research.
Todd Rosenbluth: Are there certain investment styles where you use ESG ETFs (equity/fixed income, US vs international, etc.)? Is a lack of products the main reason(s) to hold back?
Biegeleisen: At 3EDGE in an effort to be able to provide solutions that some clients and prospects have inquired about, we have created an ESG-focused strategy that utilizes our same investment process which combines valuation, economic and behavioral characteristics to determine macro asset class allocations, but with a different process around ETF ticker selection. Once the risk-adjusted projections are determined for each asset class, we then combine ESG scores along with carbon footprint scores at the ETF level for each asset class to determine which ETF to use.
Harper: We have only recently begun really digging into the ESG universe and sort through the blizzard of new offerings. Our first client inquiries into ESG came from some large European clients several years ago. Over the last six months we have seen a meaningful pickup in U.S. client interest, so we recently decided to do a deep dive into ESG and develop client solutions. We're open to most any 40 act vehicles, but ETFs would be our preference (for tax efficiency and transparency).
Mallen: We tend to focus on the major asset classes within our ESG models (US Large Cap, Developed International, etc.). The universe has definitely evolved to make a diversified portfolio of ESG-only ETFs possible. There are some more esoteric asset classes that have yet to catch up, but I expect those to be available soon.
TR: Are you choosing to include ESG in traditional models or running them separately?
Biegeleisen: That is a great question and one we have had some debate about internally. In some cases, the ESG ETFs have outperformed their more plain-vanilla counterparts which would suggest that rather than focusing on an overall ESG strategy, perhaps we should blend one or multiple of the ESG tickers themselves into our more core strategies. On the other hand, we don’t know that this outperformance will last, and there is still to some degree a level of skepticism that clients may have about ESG investments, i.e., the feeling of giving up return to "do good".
Harper: We are exploring two types of ESG offerings. The first would allow approved ESG funds be used as substitutes into an existing standard model (kind of like a kit car where you can substitute body panels). In this way we could offer clients a range of ESG fund/objective options and asset classes while separately giving them a rough estimate for the performance or volatility impact on the portfolio. The downside with this method is that the theoretic permutation of traded models can become dizzying.
Second would be to come up with a few dedicated ESG asset class sleeves (stocks, bonds, cash) that could be allocated to as stand-alone thematic buckets (e.g. ESG safety bucket, ESG conservative bucket). We'd most likely begin these as satellite solutions rather than core solutions.
Mallen: Almost entirely separate. We look at ESG not so much as a core investment needed in a portfolio, but rather a filter required by certain clients. We've found that many advisors utilize ESG as an off-shoot to an already existing asset allocation model. By taking their Moderate asset allocation and replacing each of the current funds with an ESG solution, they are able to convey the same story but satisfy the ESG request from clients.
TR: How has the end user response been? Are you hear consistency about how they view ESG?
Biegeleisen: The feedback is inconsistent. While most recognize the coming wave of ESG investing, it is variable in terms of interest in actually making the decision to invest that way. One area that we are focused on is defining impact reporting. We envision a future where a client receiving their quarterly statement also receives alongside a personal impact report. This report ideally would illustrate that by having invested with this ESG focus compared with more traditional plain vanilla indexes, some reduction in carbon outlay (or equivalents), an ‘x’ number of trees have been planted (or equivalents), and gallons of fresh water were saved (or equivalents), etc. but with respect to their actual dollars invested. We have spent a good deal of time talking with ESG experts about this, and many seem to be working towards this effort, but no one is quite there yet.
Harper: We are getting steady and growing inquiries from clients about what ESG options they have. To date this has come predominantly from the high net worth clients, but interest has been steadily trickling down into the mass affluent. Most interest to date has been toe-in-the water interest, but the requests are only getting louder.
Mallen: Interest has definitely escalated. I think marketing by fund companies has helped. I honestly think it may be a byproduct of an extended bull market. When markets have been positive for so long, clients are privileged enough to make further demands from their investment portfolio. Returns are no longer good enough, but now they want to change the world with their money as well. I think a recession or extended bear market will negatively impact the demand for these types of funds.
Todd Rosenbluth is the director of ETF and mutual fund research at CFRA. Learn more about CFRA's ETF research here.