How to choose an ESG exchange-traded fund

"Retail investors with the highest social convictions may prefer purer ESG exposures but at the expense of diversification. Meanwhile, clients with lower social convictions may prefer funds that track broad market cap indices more closely."

This point on diversification may weigh against investor’s intentions to invest ethically.

So, what is the best balance between capturing positive performance, greatest accessibility to the market, diversification, as well as backing socially responsible companies? And how can putting money behind the right companies transition them into leading the way into the future?

Here, the question of stewardship comes in, again requiring some analysis of the differences between passive funds and actively managed funds. 

Tom Bailey, ETF specialist at Interactive Investor, feels one of the key points to make is that “retail investors by and large do not use ESG-screened vanilla index ETFs, when compared to non-ESG-screened ones."

He continues: “We can see that in the most-bought data. However, ETF investors do seem very keen on thematic ETFs with an ESG-like focus. I’m talking here about products such as the iShares Global Clean Energy ETF and L&G Battery Value ETF.

"These are ETFs that invest in technologies that will enable decarbonisation of the economy – I can imagine for many ETF (and young) investors this is a more compelling story than being told ‘this MSCI whatever index ETF screens and re-weights according to ESG metrics’."

Bailey is talking about using ETFs to invest in companies that proactively develop green solutions.

Advisers' role 

There are several different mechanisms including screening, thematic, and stock-selective management employed for ETFs, however, which WisdomTree's Treiber points out as an advantage of the flexibility of the investment product. 

This means investors can, with their advisers, find the right ESG ETF for them, following the investment style they prefer rather than having to take an off-the-peg solution.

Treiber points out that: “ESG related ETFs are not a one-size-fits-all solution. Some investors are looking to support specific ESG initiatives, which could be best served through thematic investing.

"Others are looking to make traditional asset class exposures more environmentally friendly. This could be done by selecting strategies that screen the relevant investment universe and exclude companies that do not meet certain ESG criteria, such as the UN's Global Compact Principles or the UN’s Sustainable Development Goals.”

She says advisers should “work alongside clients to evaluate what areas match their goals and investment objectives when selecting ESG-related ETFs”.

But advisers' opinions can be divided on the use of ETFs to meet a specific ESG need. For example, Darius McDermott, managing director of Chelsea Financial Services, argues that passive funds have low stewardship potential.

ETF investors do seem very keen on thematic ETFs with an ESG-like focus.Bailey