In Focus: Passive Investing  

How to choose an ESG exchange-traded fund

  • To understand how ESG operates within an ETF.
  • To be able to explain the pros and cons to clients seeking ESG ETFs.
  • To learn how to assess the stewardship potential of passive ESG funds
How to choose an ESG exchange-traded fund
Photo by Singkham via Pexels

In the mid-2000s, environmental, social and governance funds had only just begun to blossom.

Contrast this nascent growth to what ESG funds have become today.

Their vast growth in popularity has developed in line with a growing awareness of the vital potential of finance – as an industry and as a resource – in changing the course of history.

That is, investing, developing and researching financial solutions to global climate change, and developing businesses that are more equitable and sustainable by paying attention to the social responsibility of a company and those with whom it works.

As the debates coming out of COP26 in Glasgow suggests, never before has it been more necessary to focus the lens onto global financial practices, and onto how investors can put their money where their morals are.

This sense of urgency around ESG investment and its rising popularity among retail investors may explain why exchange-traded funds have become increasingly part of the picture.

ETFs, which offer a flexible, low-cost entry point for investors into stocks and shares, are being placed under the microscope around areas such as stewardship, transparency, performance, and accessibility.

This is never more so than when examining whether ESG ETFs are an effective option for clients wanting to invest sustainably while meeting performance requirements. 

Popularity of ETFs

The growth in popularity of ETFs is recounted by Christopher Mellor, head of EMEA ETF equity and commodity product management at Invesco.

He says there has been a “five-fold increase in ETF assets over the past decade”. Current estimates put assets under management in the ETF market at $9tn (£6.6tn) globally and rising. 

One of the most significant trends in investor behaviour in recent years has been the “shift to ESG investments and ETFs have been a part of this movement", he says, pointing to data that states European-domiciled ESG ETFs have taken in 45 per cent of all net new ETF assets this year, up from 40 per cent of flows in 2020.

This is backed by Lidia Treiber, director of research at WisdomTree, who highlights progression in the field over the past year: "The strong demand from investors for more ESG investment solutions amid the pandemic has led to the industry responding with a growing number of new ESG-focused ETF solutions."

According to WisdomTree, European investors are keen on putting money into ethical and sustainable passive funds.

ESG ETFs captured 50 per cent of European flows in 2021 compared to just 6 per cent in the US ETF market, highlighting the greater focus on ESG from European investors.

Globally, the ESG ETF industry has taken massive strides in 2021, with ETF providers innovating to offer investors 174 new ESG ETFs in the first nine months of the year alone, she points out.

Reasons behind this growth in popularity are provided by Morningstar’s Monika Dutt, director of passive strategies research.